Chapter 27 – Options BA 543 Financial Markets and Institutions

Chapter 27 – Options Markets What was the embedded cost in the Futures Contract for a hedger? What would be the preferred set-up for a hedger? Avoid the bad prices Enjoy the good prices Who would be willing to take the other side of the contract? What economic incentive would you need to offer? Does this sound like Insurance?

Chapter 27 – Options Markets The payoff profile desired for producer Get Fixed Price during Falling Prices, Get Market during Rising Prices

Chapter 27 – Options Markets An options contract fits the “bill” Two types of options, Call Option – The right but not the obligation to buy Put Option – The right but not the obligation to sell It takes two to make a contract Buyer of the option Seller (Writer) of the option

Chapter 27 – Options Markets What are the characteristics of an option contract? The agreed to underlying (remember this is a derivative asset) The agreed to price for transaction in the future (here it is the strike or exercise price) The time horizon for the option (maturity date) The payment to the seller or writer for providing the contract option to the buyer Styles, American or European

Chapter 27 – Options Markets Just the Basics of the Call Option Buyer’s options: exercise or do nothing Seller’s obligation: perform Pay-off Profile Just the Basics of the Put Option Buyer’s options: exercise or do nothing Seller’s obligation: perform Pay-off Profile Just like Insurance (you have an option)

Chapter 27 – Options Markets U.S. Markets and the Underlying Assets Stock Options Started Call Options at CBOE in 1973 Put Options not granted until 1977 Markets not very broad until early 80s Options Clearing Corporation (OCC) Stock Index Options Started in February 1982 with Value Line Index on the Kansas City Board of Trade (1675 stocks) First at CBOE was the S&P 100

Chapter 27 – Options Markets U.S. Markets and the Underlying Assets (continued) LEAPS (Long-term Equity Anticipation Securities) Stock and Index Options with maturities up to 39 months Spans the market as typical stock and index options only out 6 months Interest Rate Options Options on physicals Options on Futures

Chapter 27 – Options Markets Option Varieties FLEX Exotic Etc. International Option Exchanges Options on Futures Mechanics Popularity Pricing of Options

Chapter 29 – Applications Applications - Insurance Futures Applications Options Applications Applications – Speculative Futures Options Strategies Covered Call Writing Protective Put Straddles Spreads