Chapter 27 OPTIONS MARKETS. Options Contracts zThe right, not the obligation, to either buy or sell a specified amount of a specific asset at a specified.

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Presentation transcript:

Chapter 27 OPTIONS MARKETS

Options Contracts zThe right, not the obligation, to either buy or sell a specified amount of a specific asset at a specified price within a specified period of time.

Options Terminology zOption price or option premium zExercise price or strike price zExpiration date or maturity date zCall option or put option zAmerican option or European option zMaximum profit or maximum loss zExchange-traded options or over-the- counter options

Differences Between Options and Futures Contracts zBoth parties to a futures contract accept an obligation to transact, while only the options writer has such an obligation. zThe option buyer has a limited, known maximum loss. zThe risk/return profile of an option position is asymmetric, while that of a futures position is symmetric.

Risk/Return Characteristics of Call Options zThe purchase of a call is like taking a long position in the underlying asset with a fixed, maximum loss. yBenefits the buyer if the price of the underlying asset rises. yBenefits the seller if the price of the underlying asses falls or is unchanged.

Risk/Return Characteristics of Put Options zThe purchase of a put is like taking a short position in the underlying asset with a known maximum loss. yBenefits the buyer if the price of the underlying asset falls. yBenefits the seller if the price of the underlying asset rises or is unchanged.

Economic Role of the Options Market zHedging With Futures yMinimizes the risks of adverse price movements. yGives up the benefits of favorable price movements. zHedging With Options yLimits price risk. yMay benefit from favorable price movements. yMay mold a risk/return relationship.

U.S. Options Markets zStock Options zStock Index Options zFutures Options zLEAPS z Interest Rate Options z Flex Options z Exotic Options

Futures Options zGives the buyer the right to acquire a position in a futures contract. yA long position in the case of a call option. yA short position in the case of a put option. zFutures options are the option of choice in the fixed-income market.

Reasons for Popularity of Futures Options zFutures options on Treasury coupon futures do not require payments for accrued interest to be made. zFutures options are believed to be cleaner instruments due to reduced likelihood of delivery squeezes. zTo price any option, it is necessary to know the price of the underlying asset at all times.