 Options are binding contracts that involve risk, and are time bound  You buy an option when you want to protect a “position” (long or short on a stock)  An option gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date (expiration)

 I want to buy a Wii but I think the price of the Wii will go up in the coming months  Nintendo sells me an “option” to buy the Wii at $100 before December 30, 2016  I pay Nintendo $25 for this option  What happens if the price of the Wii goes to $175?  I saved $50, or I can sell the Wii and pocket the $50

 What does Nintendo get?  $25 from my option, $100 from the sale of the Wii – they lose $50  What if the price fell to $75?  I would have paid $100 for the Wii (a loss of $25)  Nintendo would have received $100 (a gain of $25)  Options are NEVER zero sum – someone always loses

 I could also decide not to buy the Wii at all  My only risk would have been what I paid for the option ($25)

 Call Gives the holder the right to buy an asset at a certain price within a specific period of time Calls are similar to having a long position on a stock Buyers of calls hope that the stock will increase substantially before the option expires Sellers of calls hope that the stock price will decrease so that the call is “out of the money” and expires unclaimed

 Put Gives the holder the right to sell an asset at a certain price within a specific period of time Like having a short position on a stock Buyers of puts hope that the price of the stock will fall before the option expires Sellers of puts hope the price goes up so that the option expires unclaimed or “out of the money”

 Seller of Put – Writer  Buyer of Put – Holder  Seller of Call – Writer  Buyer of Call – Holder  Holders have a choice whether to exercise their options  Writers are obligated to make good on the contract  Therefore, who assumes the most risk?

 Options on stock are sold in 100 share lots, so you must multiply the option price by 100  Example: an option is $2.00  Your total cost is $ for 100 shares  Most option holders sell their options on the secondary market before expiration (about 90%)  Only 10% hold until expiration

 Outlay is minimal If you had to buy 100 of the the underlying shares of a stock for $50, you would be spending $5,000 out of pocket With an option, you don’t have to own the underlying stock You buy an per share (for 100 shares), cost you a total of $200 But because options are so volatile, you have a better chance of losing your $200 than your $5,000

BUY SHARES LONGUNCOVERED CALL OPTION  Buy 100 $50 = $5,000  Price of stock goes up to $62  Now worth $6,200  Sell and make $1,200  Rate of return = 24%  ($6,200 - $5,000)/$5000  Purchase = $200  Price of stock goes up to $62  Option now worth $5 = $500  Sell and make $300  Rate of return = 150%  ($500-$200)/$200

 Strike Price – the price at which the underlying asset can be purchased/sold  Exercise – when you fulfill the contract by buying or selling the underlying asset according to the option terms  Expiration Date – last day you can exercise the option  Premium – cost of the option, which can change during the life of the contract

 Intrinsic Value For call options, the option is said to be in- the-money if the share price is above the strike price A put option is in-the-money when the share price is below the strike price The amount by which an option is in-the- money is referred to as intrinsic value

 Time Value Dollar value assigned to the potential that the option has to continue to make gains before expiration Share Market Price$ 10 - Exercise Price($ 5) Intrinsic Value$ 5 Premium$ 7 - Intrinsic Value($ 5) Time Value$ 2

 In-the-Money The underlying stock is above the strike price  At-the-Money The underlying stock is at the strike price  Out-of-the-Money The underlying stock is below the strike price

 In-the-Money The underlying stock is below the strike price  At-the-Money The underlying stock is at the strike price  Out-of-the-Money The underlying stock is above the strike price

 Merck has a ticker symbol of MRK  It’s option ticker can have several different versions  The symbol depends on Type of option (call or put) Strike price Month of expiration  The strike price is always the one closest to the current stock price

 You think the price might go up or down dramatically  You want to make money without a big cash outlay  You want to protect a current position against a big loss  You want to make some money back after a previous loss