CONTENTS Definitions. Definitions. Four principals types of options. Four principals types of options. Examples. Examples. Complexes strategies. Complexes strategies.

Definitions An option is a contract, or a provision of a contract, that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. An option is a contract, or a provision of a contract, that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. call options, which provide the holder the right to purchase an underline asset at a specified price, in the specified terms. call options, which provide the holder the right to purchase an underline asset at a specified price, in the specified terms. put options, which provide the holder the right to sell an underline asset at a specified price, at the specified terms. put options, which provide the holder the right to sell an underline asset at a specified price, at the specified terms.

The strike price ( E ) of a call (put) option is the contractual price at which the underline asset will be purchased (sold) in the event that the option is exercised. The strike price ( E ) of a call (put) option is the contractual price at which the underline asset will be purchased (sold) in the event that the option is exercised. The last date on which an option can be exercised is called the expiration date. Options may allow for one of two forms of exercise: a/ American exercise, the option can be exercised at any time up to the expiration date. b/ European exercise, the option can be exercised only on the expiration date. An option is said to be at-the-money if the underline value currently equals the strike price. An option is said to be at-the-money if the underline value currently equals the strike price. The option is said to be in-the-money if it has positive intrinsic value or out-of-the-money if it has zero intrinsic value. The option is said to be in-the-money if it has positive intrinsic value or out-of-the-money if it has zero intrinsic value.

Maximum earnings: unlimited in theory = N*[ C – ( E + Pc )] Maximum loss : total of premium ( -N*Pc ). With N : number of options

Maximum earnings = [ E – (P + Pp)]*N Maximal loss = total of premium

Call Put Position Result Call Put Position Result E>PS E PS E<PS Out of the money Loss E=PS E=PS At the money Loss E PS In the money Earning E = Strike Price. PS = Price of the market. Pp = premium of PUT Pc = premium of CALL Example: Exercising a CALL option Suppose that on March 20, you purchased one contract (100) of September-100 IBM call options. At that time, the price of an IBM share was $100 and the price of the call options on the Chicago Board Options Exchange (CBOE) was $12.80 Suppose that on March 20, you purchased one contract (100) of September-100 IBM call options. At that time, the price of an IBM share was $100 and the price of the call options on the Chicago Board Options Exchange (CBOE) was $12.80

That is, at the time of entering the contract, you paid: N * P=100($12.80) = $1280 for the right to purchase 100 IBM shares for $100 each at any time before the contract matures. It is now September 20, which is the maturity date for September options, and the IBM stock price is $120. It is now September 20, which is the maturity date for September options, and the IBM stock price is $120. In this case, you will want to exercise the option: you pay 100($100) = $10,000 and receive 100 IBM shares (which are worth $12,000) Earnings= N*[ C – ( E + Pc )] = 100*[ 120-( )]= 720 $ However, that the IBM stock price was only $95. However, that the IBM stock price was only $95. In this case, you would let the option lapse and no funds would change hands Loss = N*Pc =100* 12.8= 1280 $

Example: Exercising a PUT option The same example but the price of the put options on the Chicago Board Options Exchange (CBOE) was $5.33. At the time of entering the contract, you paid 100($5.33) = $533 for the right to sell 100 IBM shares for $100 each at any time before the contract matures. It is now September 20, which is the maturity date for September options, and the IBM stock price is $120. It is now September 20, which is the maturity date for September options, and the IBM stock price is $120. In this case, you will not want to exercise the option and you loose $533 for the premium. However, that the IBM stock price was only $90, you would exercise the option. You receive 100($100) = $10,000 in return for 100 IBM shares (which are worth only $9,000). However, that the IBM stock price was only $90, you would exercise the option. You receive 100($100) = $10,000 in return for 100 IBM shares (which are worth only $9,000). Earnings = N * [ E – ( P + Pp )]=100* [ 100 – ( )] = 467$ Remark : This loss or earnings is without transaction cost.

An option spread is a position comprising two or more options on the same underline. Some spreads have standard names. An option spread is a position comprising two or more options on the same underline. Some spreads have standard names. A straddle comprises a PUT and a CALL with the same expiration and struck at the same price (usually at the money). A straddle comprises a PUT and a CALL with the same expiration and struck at the same price (usually at the money).at the moneyat the money A straddle is a bet on high volatility. It makes money if the underline value moves significantly either up or down. A strangle is similar to a straddle, but both options are struck out of the money. For this reason, a strangle is cheaper than a straddle, but it requires a larger move in the underline to be profitable. A strangle is similar to a straddle, but both options are struck out of the money. For this reason, a strangle is cheaper than a straddle, but it requires a larger move in the underline to be profitable.

Maximum earnings = [ E – ( Pc + Pp )]*N if PUT exerces. = unlimited in theory if CALL exerces. = unlimited in theory if CALL exerces. Maximal loss = total of premium : [ N * ( Pc + Pp ) ]

Maximum earnings = [ E – ( Pc + Pp )]*N if PUT exerces. = unlimited in theory if CALL exerces. = unlimited in theory if CALL exerces. Maximal loss = total of premium : [ N * ( Pc + Pp ) ]