change-

ex
D
C Options on
ded funds B A ETFs and
Stock
put
options Indexes
 D Exchange-
C Options on
B traded funds A
ETFs and
Stock
ut
ions Indexes
d
d
D Exchange-
C Stock index options
traded funds B
y A

call put options

options
 If the stock
portfolio is
D Hedging Exchange-C
broad enough,
Stockany changes in
index
with
Stock
traded funds B A
options
its value will
highly
Index
correlated with
Options
market
put
movement.
call
options
options
 If the stock
Hedging
Hedging
Exchange-
Stock
marketD
C
index a
experiences
withwith
Stock
traded funds B A
options
severe
Stock downturn, the
Index
Index
Options market value
Options of the
put
call portfolio
options
options declines.
 E
If the stock
marketExchange-
D
rises,
HedgingHedging Stock index
the put C
with with
Stock Stock
traded funds B A
options
options on
the stock
Index Index
index will not
OptionsOptions
be exercised. put
call
options
options
 Hedging with Long-
Term Stock Index
ange-
I Options
H
d funds G G
Long-term equity anticipations
are used by option market
t participants who wants options
ons with longer terms until
expirations.
 I Dynamic
H
G Asset F
Allocation
t
with Stock
ons Index
 Dynamic Asset
Allocation
I
H - Involves switching between
G
risky and low risk investment F
positions overtime in response
to changing expectations.
I Using Index
H
Options to G
F
Measure the
Market’s Risk
The volatility index (VIX) I
H
represents the implied G
F
volatility derived from
options.
M Options on
L
K Future
J
Contracts
 Option on
M future
L
K contracts J
An option on particular futures
contract gives it owner the right to
purchase or sell that future contract for
specified price within specified future
period of time.
 Speculating
M with options
L
on futures K
J
Speculators who anticipate a
change in interest rates should
expect a change in bond prices.
Speculation based on an expected
decline in interest rates.

M
L
K
If the speculators expect a decline J
in interest rates, they may consider
purchasing a call option on Treasury
bond futures.
Example
Kelly Warden expects interest rates to decline and
purchases a call option on Treasury bond futures
94 .50% of $100,000. or $94,500. The call option is M
L
purchased at a premium of 2% of $ 100,000,which is
equals to $2,000. Assume that the interest rates do K
decline and, as a result , the price of the Treasury bond J
future contract rises overtime to a value of $99,000
shortly before the option’s expiration date. At this time,,
Kelly decided to exercise the option and closes out the
position by selling an identical future contracts at a
higher price at which she purchased the futures.
Q
P
Selling price of T-bond future

O Less Purchase price of T-bond

futures
Less Call option premium paid N
= Net Gain to Purchaser of
call Option of Futures

=$2,500 or 2.50% of $100,000

Q Ellen Rose sold the call option
purchased by Kelly Warden in
P the previous example . Ellen is
O
obligated to purchase and
provide the futures contract N
at the time the option is
exercise.
 Selling price of T-bond future

Q
Less Purchase price of T-bond
futures
add Call option premium recieved P
= Net loss to seller of call Option O
of Futures N

= -$2,500 or -2.50% of $100,000

When interest rates decline,
the buyers of call options on Q
Treasury bonds may simply sell P
their previously purchased O
options just before expiration. N
If interest rate rise, the options
will not be desirable.
 Speculation based on an expected
increase in interest rates.
U
T
S
R
If the speculators expect
interest rates to increase, they can
benefit from purchasing a put
option on Treasury bond futures.
 Example
John Drummer expect interest rates to

U increase, and purchases a put option on

Treasury bond futures. Assume the exercise on
T
S Treasury bond futures $97,000 and the
premium paid for the put option is $3,000.
Assume the interest rates do increase, and as a R
result , the price of the Treasury bond future
contract declines over time to a value of
$89,000 shortly before the option’s expiration
date. At this time, John decided to exercise the
option and closes out the position by
purchasing an identical future contracts.
U Selling price of T-bond future
T Less Purchase price of T-bond
futures S
Less Put option premium paid R
= Net Gain to Purchaser of
call Option of Futures

=$5,000 or 5.00% of $100,000

 Hedging with
UOptions on Interest
T
Rate Futures S
R
Options on future contracts are used
to hedge against risk. Financial
institutions commonly hedge their bond
or mortgage portfolio with option on
interest rate future contracts.
 Scenario 1 Scenario 2
• Interest rate rise • Interest rate
• T-bond future decline
price declines to • T-bond future
91-00 price increases to
104-00

Effect on Emory’s Spread is reduce Spread is increase, but U

T
spread mortgage prepayment
may occur

Effect on T-bond Future price Future price increases

S
R
futures price decreases
Decision on exercising Exercise put option Do not exercise put
the put option option
Selling price of T- $98,000 Not sold
bond futures
- Purchase price of T- - $91,000 Not purchased
bond futures
- Price paid for put -$2,000 -$2,000
option
=NET GAIN PER $5,000 -$2,000
OPTION
 Hedging with
Y Options on
X Stock Index
W
V
Futures
Financial institutions and other
investors commonly hedge their stock
portfolios with options on stock index
future contracts.
 Example
You currently manage a stock portfolio that is
valued $400,000, and you plan to hold these

Y
stocks over a long-term period. However, you
are concerned that the stock market may
X experience a temporary decline over the next
W three months and that your stock portfolio will
probably decline by about same degree as the
market. You want to create a hedge so that your
V
portfolio will decline no more than 3% from its
present value, but you would like to maintain
any upside potential. You can purchase a put
option on index futures to hedge your stock
portfolio. Put options on S&P 500 index futures
are available with expiration date about 3
months now.
 Assume that the S&P index level is currently 1600
and that one particular put options on index
futures has a strike price of 1552 (3% less than
Y prevailing index level) and a premium of 10.

X
W Since the options on S&P 500 index futures are

V
priced at $250 times the quoted premium, the
dollar amount to be paid for this option is

10 x $250= $2,500

If the index level declines below 1552 then

you may exercise the put option on index
futures, which gives you the right to sell the
index for the price of 1552.
 At the settlement date of the futures contract you
will receive

(Future Price-prevailing index level)x $250

Y (1552-1520)x $250= $8,000
X If the market declines by 5% , for example from
W
V
1600 to 1520. There will be a gain on the future
index future contracts.

Meanwhile, a 5% decline in portfolio reflects a

loss of

$400,000 x 5%= $20,000

 Determining the Degree of the Hedge
with Options on Stock Index Futures.

Y
X
When using put W
options to hedge,
V
various strike prices
exist for a option on a
specific stock index
for a specific
Selling Call Options to Cover The
Cost of Put Options.

In the previous example, the cost Y

X
of hedging with a put options on
W
index future is $2,500. Given your
expectations a weak stock market V
over the next 3 months, you could
generate some fees by selling call
options on S&P 500 index futures
to help cover the cost of your
purchasing put options.
 Assume that there is a call option
on S&P 500 index futures with a
strike price of 1648 (3% above

3 the existing index level) and a

premium of 10. You can sell a call
2 option for 2500 (10 x 250$) and
1 use the proceeds to pay the
Z If the market
premium risesput
on the by options.
5% over the 3
month period the S&P index level will rise
to 1680.

payment = $8,000
 Option as
3 Executive
2 Compensation
1
Z
Many firms distribute stock option s to
executives and other managers as a
reward for good performance.
 Limitation of Option
Compensation
3 Many option compensation programs do
2 not account for general market
1
conditions..
Z
Executives with substantial options may
be tempted to manipulate the stock ‘s
price upward in the short term, even
though doing so adversely affects the
stock price in the long-term.
3
Globalization 2
1
of Option Z
Markets
 Currency Options
Contracts
3
2
1
Z
Currency call options

Currency put options

 Thank you
for listening
!!