1. Options
Professor Brooks
BA 444
01/09/08

2. The First Known Option Trader
Philosopher Thales of Milesian.
Used the stars to determine the olive crop would be large that year.
Paid a deposit on all the olive presses in the area for use in the harvest season
Olive crop harvest large
Presses in high demand
Rented presses out a rate higher than he had secured with his deposit…made $$$$$

3. Types of Options Only Two
Call – Right but not the obligation to buy the underlying asset on or before a set date at a pre-set price (strike or exercise price)
Put – Right but not the obligation to sell the underlying asset on or before a certain date at a pre-set price (strike or exercise price)

4. Categories of Options American vs. European Underlying Asset
Equity Option – Stock
Index Option – Financial Index
Futures Option – Futures Contract
FX Option – Foreign Exchange
Interest Rate Option – Treasury Bond

5. Standardized Option Contract
Traded on an Exchange
ISE, CBOE, AMEX, Philly, PSE
Set Size of Underlying Asset
Equities are 100 shares of stock
Futures are the size of futures contract
Specific Expiration Date (Third Friday)
Specific Strike Price (Exercise Price)
Price of Option is current selling/buying price of the financial asset.

6. Options Basics A basketball ticket…
Owner of the ticket has the right to
Attend the game
Sell the ticket to someone else
“Eat” the ticket, not use or sell the ticket
Original seller must provide the “seats” for the game if exercised by either original buyer or subsequent buyer of the ticket
Price of the ticket will vary through time based on the performance of the teams and the time left before tip-off

7. Four Positions in Options & Risk
Buy a Call – Risk is cost of option
Sell a Call – Risk is rising prices
Buy a Put – Risk is cost of option
Sell a Put – Risk is falling prices
Diagrams of four positions
Hockey Sticks of Options
Reveals potential gains and losses

8. Trading Options Option Ticker Symbols Bid Prices and Ask Prices
Page 23…
Example at ISE,
Bid Prices and Ask Prices
Bid, price at which one is willing to buy
Ask, price at which one is willing to sell
Market vs. Limit
Order Book Official (Limit order book)
Preference to price and time

9. Trading Options -- Continued
Exercise a Call (holder of option)
Notify OCC
Put up the strike price
Receive the underlying asset
Exercise a Put (holder of option)
Put up the underlying asset
Receive the strike price
Or Sell the Call or Put

10. Option Values Price of the option
intrinsic value
Call Max (0, S-K)
Put Max (0, K-S)
Plus time value
Illustrate Intrinsic value…profit from exercising
Illustrate time value of option with binomial tree
Never exercise Call option (lose time value)