Investments, 8 th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 20 Options Markets: Introduction

20-2 Buy - Long Sell - Short Call Put Key Elements –Exercise or Strike Price –Premium or Price –Maturity or Expiration Option Terminology

20-3 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 Market and Exercise Price Relationships

20-4 Figure 20.1 Stock Options on IBM

20-5 American - the option can be exercised at any time before expiration or maturity European - the option can only be exercised on the expiration or maturity date American vs. European Options

20-6 Stock Options Index Options Futures Options Foreign Currency Options Interest Rate Options Different Types of Options

20-7 Notation Stock Price = S T Exercise Price = X Payoff to Call Holder (S T - X) if S T >X 0if S T < X Profit to Call Holder Payoff - Purchase Price Payoffs and Profits at Expiration - Calls

20-8 Payoff to Call Writer - (S T - X) if S T >X 0if S T < X Profit to Call Writer Payoff + Premium Payoffs and Profits at Expiration - Calls

20-9 Figure 20.2 Payoff and Profit to Call Option at Expiration

20-10 Figure 20.3 Payoff and Profit to Call Writers at Expiration

20-11 Payoffs to Put Holder 0if S T > X (X - S T ) if S T < X Profit to Put Holder Payoff - Premium Payoffs and Profits at Expiration - Puts

20-12 Payoffs to Put Writer 0if S T > X -(X - S T )if S T < X Profits to Put Writer Payoff + Premium Payoffs and Profits at Expiration – Puts Continued

20-13 Figure 20.4 Payoff and Profit to Put Option at Expiration

20-14 InvestmentStrategyInvestment Equity onlyBuy shares$10,000 Options onlyBuy options$10,000 LeveragedBuy options $1,000 equityBuy 3% $9,000 Yield Equity, Options & Leveraged Equity

20-15 IBM Stock Price $95$105$115 All Stock$9,500$10,500$11,500 All Options$0 $5,000$15,000 Lev Equity $9,270 $9,770$10,770 Equity, Options Leveraged Equity - Payoffs

20-16 IBM Stock Price $95$105$115 All Stock-5.0%5.0% 15% All Options-100% -50% 50% Lev Equity -7.3%-2.3% 7.7% Rates of Return

20-17 Figure 20.5 Rate of Return to Three Strategies

20-18 Table 20.1 Value of Protective Put Portfolio at Option Expiration

20-19 Figure 20.6 Value of a Protective Put Position at Option Expiration

20-20 Figure 20.7 Protective Put versus Stock Investment (at-the-money option)

20-21 Table 20.2 Value of a Covered Call Position at Expiration

20-22 Figure 20.8 Value of a Covered Call Position at Expiration

20-23 Straddle (Same Exercise Price) Long Call and Long Put Spreads - A combination of two or more call options or put options on the same asset with differing exercise prices or times to expiration. Vertical or money spread: Same maturity Different exercise price Horizontal or time spread: Different maturity dates Option Strategies

20-24 Table 20.3 Value of a Straddle Position at Option Expiration

20-25 Figure 20.9 Value of a Straddle at Expiration

20-26 Table 20.4 Value of a Bullish Spread Position at Expiration

20-27 Figure Value of a Bullish Spread Position at Expiration

20-28 If the prices are not equal arbitrage will be possible Put Call Parity

20-29 Stock Price = 110 Call Price = 17 Put Price = 5 Risk Free = 5% Maturity = 1 yr X = > 115 Since the leveraged equity is less expensive, acquire the low cost alternative and sell the high cost alternative Put Call Parity - Disequilibrium Example

20-30 Table 20.5 Arbitrage Strategy

20-31 Optionlike Securities Callable Bonds Convertible Securities Warrants Collateralized Loans

20-32 Figure Values of Callable Bonds Compared with Straight Bonds

20-33 Figure Value of a Convertible Bond as a Function of Stock Price

20-34 Figure Collateralized Loan

20-35 Figure Return on Indexed Linked CD

20-36 Table 20.6 Prices of Digital Options on Initial Jobless Claims

20-37 Figure Implied Probability of Jobless Claims Derived from Traded Digital Options

20-38 Exotic Options Asian Options Barrier Options Lookback Options Currency Translated Options Digital Options