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Introduction to Options
Derivative Securities
Tunis Business School
Study Objectives
1. Define Options.
2. Describe the characteristics of Options.
3. Calculate the payoffs and profits to option owners and writers (sellers).
4. Establish the Call-Put Parity relationship.
Definition
• An Option provides to its holder the right but
not the obligation to buy (Call) or to sell (Put) a
certain quantity of an asset, called the
underlying, before (American Options) or at
(European Options) a fixed date, called the
maturity (or the expiry date) (T), and through
a fixed price, called the strike price (or the
exercise price) (K).
• This right is acquired after the payment of a
premium.
Option Terminology
• Buy - Long
• Sell - Short
• Call
• Put
• Key Elements
– Exercise or Strike Price
– Premium or Price
– Maturity or Expiration
Exercise
• A stock is worth initially at the Spot market
100 $ . You bought a Call having this stock as
underlying , a maturity of 1 month and a strike
price of 100 $.
• Find analytically and graphically, the pay-off at
maturity as well as the profit depending on
the following ST.
• ST 80; 90; 100; 102; 110; 120
• The premium paid initially to acquire the Call
is 2$.
Exercise
• A stock is worth initially at the Spot market
100 $ . You bought a Put having this stock as
underlying , a maturity of 1 month and a strike
price of 101 $.
• Find analytically and graphically, the pay-off at
maturity as well as the profit depending on
the following ST.
• ST 80; 90; 99; 100; 101; 110; 120
• The premium paid initially to acquire the Put is
2$.
Market and Exercise Price Relationships
In the Money - exercise of the option would be
profitable
Call: market price>exercise price
Put: exercise price>market price
Out of the Money - exercise of the option would not be
profitable
Call: market price<exercise price
Put: exercise price<market price
At the Money - exercise price and asset price are equal
Figure 20.1 Stock Options on IBM
American vs. European Options
Notation
Stock Price = ST Exercise Price = X
Payoff to Call Holder
(ST - X) if ST >X
0 if ST < X
Profit to Call Holder
Payoff - Purchase Price
Payoffs and Profits at Expiration - Calls
• Asian Options
• Barrier Options
• Look-back Options
• Binary Options
• Compound Options
• …
Exercise