McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Options Markets CHAPTER 14

14-2 Option Terminology Buy - Long Sell - Short CallPut Key Elements –Exercise or Strike Price –Premium or Price –Maturity or Expiration

14-3 Market and Exercise Price Relationships In the Money - exercise of the option would be profitable 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 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 At the Money - exercise price and asset price are equal

14-4 Figure 14-1 Options on IBM June 7, 2004

14-5 American vs European Options American - the option can be exercised at any time before expiration or maturity 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 European - the option can only be exercised on the expiration or maturity date

14-6 Different Types of Options Stock Options Index Options Futures Options Foreign Currency Options Interest Rate Options

14-7 Figure 14-2 Index Options

14-8 Payoffs and Profits on Options at Expiration - CallsNotation Stock Price = S T Exercise Price = X Stock Price = S T Exercise Price = X Payoff to Call Holder ( S T - X) if S T >X ( S T - X) if S T >X 0if S T < X 0if S T < X Profit to Call Holder Payoff - Purchase Price

14-9 Payoffs and Profits on Options at Expiration - Calls Payoff to Call Writer - ( S T - X) if S T >X 0if S T < X 0if S T < X Profit to Call Writer Payoff + Premium

14-10 Figure 14-3 Payoff and Profit to Call at Expiration

14-11 Figure 14-4 Payoff and Profit to Call Writers at Expiration

14-12 Payoffs and Profits at Expiration - Puts Payoffs to Put Holder 0if S T > X (X - S T ) if S T < X Profit to Put Holder Payoff - Premium

14-13 Payoffs and Profits at Expiration - Puts Payoffs to Put Writer 0if S T > X -(X - S T )if S T < X Profits to Put Writer Payoff + Premium

14-14 Figure 14-5 Payoff and Profit to Put Option at Expiration

14-15 Equity, Options & Options Plus T-Bills - Text Example InvestmentStrategyInvestment Equity onlyBuy shares$9,000 Options onlyBuy options$9,000 Calls PlusBuy options $1,000 T-BillsBuy 2% $8,000 Yield

14-16 Equity, Options & Options Plus T-Bills - Text Example IBM Stock Price $85$100$110 All Stock$8,500$10,000$11,000 All Options$0$9,000$18,000 Lev Equity $8,160$9,160 $10,160

14-17 Equity, Options & Options Plus T-Bills - Text Example IBM Stock Price $85 $100$110 $85 $100$110 All Stock-5.56% 11.11% 22.22% All Options-100% 0%100% Lev Equity -9.93% 1.78%12.89%

14-18 Figure 14-6 Returns to Three Strategies

14-19 Option Strategies Protective Put Covered Call Long Stock Long Stock Long Put Short Call Straddle Bullish Spread Long CallLong Call Low Ex. Long PutShort Call High Ex.

14-20 Table 14-1 Payoff to Protective Put Strategy

14-21 Figure 14-7 Value of Protective Put Position at Maturity

14-22 Figure 14-8 Protective Put Versus Stock Investment (at-the-money put)

14-23 Table 14-2 Payoff to a Covered Call

14-24 Figure 14-9 Value of a Covered Call Position at Expiration

14-25 Table 14-3 Payoff to a Straddle

14-26 Figure Payoff and Profit to a Straddle Position at Expiration

14-27 Table 14-4 Payoff to a Bullish Spread

14-28 Figure Value of a Bullish Spread Position at Expiration

14-29 Optionlike Securities Callable Bonds Convertible Securities Warrants Collateralized Loans Levered Equity and Risky Debt

14-30 Figure Value of Callable Bonds Compared with Straight Bonds

14-31 Figure Value of a Convertible Bond as a Function of Stock Price

14-32 Figure 14-4 Collateralized Loan

14-33 Exotic Options Asian Options Barrier Options Lookback Options Currency-Translated Options Binary Options