1. OPTIONS MARKETS (More on Derivative Securities)
CHAPTER 14
ECN-324
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Dr David P Echevarria

2. Options Two Types of Options Buyer Expectations
Calls
Puts
Buyer Expectations
Calls: stock prices will rise
Puts: stock prices will fall
Seller Expectations (Writer)
Calls: prices will fall or stay level
Puts: prices will rise or stay level
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Dr David P Echevarria

3. Option Writers
Option Writers may be attempting to generate additional income in sideways market.
Call Writer Positions
Covered writer; owns stock to deliver if option is exercised.
Naked writer; does not own stock (very risky position)
Highest margin requirement.
Put Option Writers
Must deposit margin equal to 50% of current value.
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Dr David P Echevarria

4. GENERAL TERMINOLOGY
Premium: the price paid per option; one option per share, contract = 100 options.
Exercise Price (XP): the fixed [share] price for future transaction.
Expiration date: the date the option expires.
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Dr David P Echevarria

5. GENERAL TERMINOLOGY
Profit (Loss) Definitions: In- At- or Out-of-the-Money
In-the-Money Call: The stock price is greater than the exercise price
At-the-Money Call: The stock price is equal to the exercise price
Out-of the Money Call: The stock price is less than the exercise price
In-the-Money Put: The stock price is less than the exercise price
At-the-Money Put: The stock price is equal to the exercise price
Out-of-the-Money Put: The stock price is greater than the exercise price
All Rights Reserved
Dr David P Echevarria

6. GENERAL TERMINOLOGY Contract Specifics (CBOE)
Contract Size is for 100 shares. For indexes, a multiple of the index
Expiration Dates: current month, next month , next two months in the cycle.
Several stocks have weekly options
Position Limits: max # of options held by one player on same side
Exercise Limits: max # of options exercised in a 5-day period.
All Rights Reserved
Dr David P Echevarria

7. GENERAL TERMINOLOGY Players in the Options Market
Market Makers: Provide liquidity, Imposes spread as charge for liquidity services
Scalpers: near simultaneous buy at bid, sell at ask to lock in the spread.
Floor Broker: executes trades for public traders.
Order Book Official: Exchange official who oversees execution of limit orders entered into the computer.
AMEX, PHLX: Specialists, Registered Option Traders (ROT):
G. Open Interest: number of option contracts Opened on a [stock].
F. Exercising an Option; making or taking delivery at the request of the option buyer.
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Dr David P Echevarria

8. TYPES OF OPTIONS Stock Options; 2009 > 1500 different issues (CBOE)
Exercise (settlement involves stock delivery).
Exercise also involves paying a commission on the purchase of stock.
Index Options: settlement in CASH
"OEX" S&P 100: Value is index value times 100
Options available on all major market indexes
Advantages of Index Option Trading
Cash settlement permits trading w/o necessity to make/take delivery.
Options cover the market as a whole.
All Rights Reserved
Dr David P Echevarria

9. OPTIONS CLEARING CORPORATION (OCC)
Guarantees writer performance and as such is an important intermediary
Handles the assignment on exercises
All firms trading or brokering in options have accounts with OCC
Sets capital requirements for members of the OCC
Hold funds deposited for margin requirements
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Dr David P Echevarria

10. MARGIN REQUIREMENTS Stocks Options Naked Calls
50% initial for long and short positions.
25% maintenance
Options
100% of the price of the contract (already leveraged).
Naked Calls
20-50% of current stock price plus/minus maintenance if option is in/out of the money.
Index options have lower margin requirements (15% due to lower volatility).
Covered Calls: Stock is usually in street name (held in margin account )
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Dr David P Echevarria

11. REGULATION OF OPTIONS MARKETS
SEC is primary regulator for options on stocks, foreign currencies, and indexes.
CFTC is primary regulator for futures options.
Exchanges also have rules, particularly in regards to capital requirements.
OCC also has certain rules for member firms to follow.
All Rights Reserved
Dr David P Echevarria

12. HOMEWORK QUESTIONS What is a derivative security and how is it valued?
What functions do derivative securities play?
What is a call option? a put option?
What bet is a call buyer making? A put buyer?
What is a naked writer?
Understand what is meant by the following terms:
Option premium
Strike (or Exercise) price
Option Contract
Naked call writing
Covered call writing
In- and out-of-the-money for calls, puts
What are index options?
How index options settled?
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Dr David P Echevarria

13. Covered Call Option Decisions Maximize Net Cash Flow Minimize Loss
FIN 330: Fundamentals of Investments
ECN-324: Financial markets and Institutions

14. Example Plays Buy Stock, Sell Covered Calls Option Strike Price such that: X > Sbuy