1. Financial Market Theory
Tuesday, November 28, 2017
Professor Edwin T Burton

2. Options
Two Kinds
Call Options (“right to purchase stock at a fixed price by a fixed date”)
Put Options (“right to sell……………)
Need not exercise the right (unlike what happens with futures)
Option could ‘expire’ worthless and nothing take place
Or could ‘exercise’ the option and buy (sell) the stock if call (put) option
Priced?
Value at maturity
Value prior to maturity
Black-Scholes Option Pricing Formula
Put-Call Parity

3. Option to buy XYZ stock at 40 by end of February: the “XYZ Feb 40 Call”
In the real world stock options are denominated in 100s
XYZ Feb 40 permits owner to buy 100 shares of XYZ stock by paying $ 4,000 at any time up to and including the maturity date of the option
If the option costs 2 ¼, then it costs $ 225, since it represents the right buy 100 shares
This definition is an “American” option
A “European” option only permits the exercise of the option on the maturity date
If no dividend, the ‘early option’ has no value

4. Value at Maturity (Expiration Date)
Value of option
$ 20
$ 40
$ 60
Stock Price at Expiration Date

5. Value at Maturity (Expiration Date)
Value of option
Prior to maturity
$ 20
At maturity
$ 40
$ 60
Stock Price at Expiration Date

6. Black and Scholes 1973 Article Assume no dividend Two variables matter
Interest rates
Volatility
Expected return does not matter