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,*,Slide Title,Body Text,Second Level,Third Level,Fourth Level,Fifth Level,Derivatives&Options,Historical Topics(Internal to the Corp),1-Capital Budgeting(,Investment,),2-Capital Structure(,Financing,),Today,We are leaving Internal Corporate Finance,We are going to Wall St&“Capital Markets”,Options-financial and corporate,Options are a type of derivative,Options,Terminology,Derivatives,-Any financial instrument that is derived from another.(e.g.options,warrants,futures,swaps,etc.),Option,-Gives the holder the right to buy or sell a security at a specified price during a specified period of time.,Call Option,-The right to,buy,a security at a specified price within a specified time.,Put Option,-The right to,sell,a security at a specified price within a specified time.,Option Premium,-The price paid for the option,above the price of the underlying security.,Intrinsic Value,-Diff between the strike price and the stock price,Time Premium,-Value of option above the intrinsic value,Options,Terminology,Exercise Price,-(Striking Price)The price at which you buy or sell the security.,Expiration Date,-The last date on which the option can be exercised.,American Option,-Can be exercised at any time prior to and including the expiration date.,European Option,-Can be exercised only on the expiration date.,All options“usually”act like European options because you make more money if you sell the option before expiration(vs.exercising it).,3 vs.70-68=2,Option Obligations,Option Value,The value of an option at expiration is a function of the stock price and the exercise price.,Option Value,The value of an option at expiration is a function of the stock price and the exercise price.,Example,-Option values given a exercise price of$85,Options,CBOE Success,1-Creation of a central options market place.,2-Creation of Clearing Corp-the guarantor of all trades.,3-Standardized expiration dates-3rd Friday,4-Created a secondary market,Options,Components of the Option Price,1-Underlying stock price,2-Striking or Exercise price,3-Volatility of the stock returns(standard deviation of annual returns),4-Time to option expiration,5-Time value of money(discount rate),Black-Scholes Option Pricing Model,O,C,=P,s,N(d,1,)-SN(d,2,)e,-rt,Black-Scholes Option Pricing Model,O,C,=P,s,N(d,1,)-SN(d,2,)e,-rt,O,C,-Call Option Price,P,s,-Stock Price,N(d,1,),-Cumulative normal density function of(d,1,),S,-Strike or Exercise price,N(d,2,),-Cumulative normal density function of(d,2,),r,-discount rate(90 day comm paper rate or risk free rate),t,-time to maturity of option(as%of year),v,-volatility-annualized standard deviation of daily returns,(d,1,)=,ln +(r +)t,P,s,S,v,2,2,v t,32 34 36 38 40,Cumulative Normal Density Function,N(d,1,)=,Cumulative Normal Density Function,(d,1,)=,ln +(r +)t,P,s,S,v,2,2,v t,Cumulative Normal Density Function,(d,2,)=d,1,-,v t,Call Option,Example,What is the price of a call option given the following?.,P=36r=10%v=.40,S=40t=90 days/365,Call Option,Example,What is the price of a call option given the following?.,P=36r=10%v=.40,S=40t=90 days/365,(d,1,)=,ln +(r +)t,P,s,S,v,2,2,v t,(d,1,)=-.3070,N(d,1,)=1-.6206=,.3794,Call Option,.3070=.3,=.00,=.007,Call Option,Example,What is the price of a call option given the following?.,P=36r=10%v=.40,S=40t=90 days/365,(d,2,)=-.5056,N(d,2,)=1-.6935=,.3065,(d,2,)=d,1,-,v t,Call Option,Example,What is the price of a call option given the following?.,P=36r=10%v=.40,S=40t=90 days/365,O,C,=P,s,N(d,1,)-SN(d,2,)e,-rt,O,C,=36.3794-40.3065e,-(.10)(.2466),O,C,=$1.70,Put-Call Parity,Put Price=Oc+S-P-Carrying Cost+Div.,Carrying cost=r x S x t,Example,IBM is selling at$41 a share.A six month May 40 Call is selling for$4.00.If a May$.50 dividend is expected and r=10%,what is the put price?,Put-Call Parity,Example,IBM is selling at$41 a share.A six month May 40 Call is selling for$4.00.If a May$.50 dividend is expected and r=10%,what is the put price?,Put-Call Parity,Op=Oc+S-P-Carrying Cost+Div.,Op=4 +40-41 -(.10 x 40 x.50)+.50,Op=3 -2 +.5,Op=$1.50,Warrants&Convertibles,Review Ch 22(not going over in class),Warrant-a call option with a longer time to expiration.Value a warrant as an option,plus factor in dividends and dilution.,Convertible-Bond with the option to exchange it for stock.Value as a regular bond+a call option.,Wont require detailed valuation-general concept on valuation+new option calc and old bond calc.,Option Strategies,Option Strategies are viewed via charts.,How do you chart an option?,Stock Price,Profit,Loss,Option Strategies,Long Stock Bought stock Ps=100,Option Strategies,Long Call Bought Call Oc=3 S=27 Ps=30,Option Strategies,Short Call Sold Call Oc=3 S=27 Ps=30,Option Strategies,Long Put=Buy Put Op=2 S=15 Ps=13,Option Strategies,Short Put=Sell Put Op=2 S=15 Ps=13,Option Strategies,Synthetic Stock=Short Put&Long Call,Oc=1.50 Op=1.50 S=27 Ps=27,P,/,L,P,s,2,7,3,0,2,4,-,1,.,5,0,+,1,.,5,0,Option Strategies,P,/,L,P,s,2,7,3,0,2,4,-,1,.,5,0,+,1,.,5,0,Synthetic Stock=Short Put&Long Call,Oc=1.50 Op=1