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Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-1 Chapter 17.

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Presentation on theme: "Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-1 Chapter 17."— Presentation transcript:

1 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-1 Chapter 17

2 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-2 Chapter Summary  Objective: This chapter is an introduction to the option markets. Options’ investment characteristics Option strategies Put-Call parity relationship Option-like securities and exotic options

3 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-3  Buy - Long  Sell - Short  Call  Put  Key Elements Exercise or Strike Price Premium or Price Maturity or Expiration Option Terminology

4 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-4  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 Call: market price > exercise price Put: exercise price > market price  At the Money - exercise price and asset price are equal Market and Exercise Price Relationships

5 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-5  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 American vs. European Options

6 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-6  Stock Options  Index Options  Futures Options  Foreign Currency Options  Interest Rate Options Different Types of Options

7 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-7 Summary Reminder  Objective: This chapter is an introduction to the option markets. Options’ investment characteristics Option strategies Put-Call parity relationship Option-like securities and exotic options

8 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-8 Notation Stock Price = S T Exercise Price = X Payoff to Call Holder ( S T - X) if S T >X 0if S T < X Profit to Call Holder Payoff - Purchase Price Payoffs and Profits on Options at Expiration - Calls

9 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-9 Payoff to Call Writer - ( S T - X) if S T >X 0if S T < X Profit to Call Writer Payoff + Premium Payoffs and Profits on Options at Expiration - Calls

10 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-10 Payoff Profiles for Calls Payoff Stock Price 0 Call Writer Call Holder

11 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-11 Payoffs to Put Holder 0if ST > X (X - ST) if ST < X Profit to Put Holder Payoff - Premium Payoffs and Profits at Expiration - Puts

12 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-12 Payoffs to Put Writer 0if ST > X -(X - ST)if ST < X Profits to Put Writer Payoff + Premium Payoffs and Profits at Expiration - Puts

13 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-13 Payoff Profiles for Puts 0 Payoffs Stock Price Put Writer Put Holder

14 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-14 InvestmentStrategyInvestment Equity onlyBuy stock @ 50200 shares$10,000 Options onlyBuy calls @ 52000 options$10,000 LeveragedBuy calls @ 5200 options $1,000 equityBuy T-bills @ 3% $9,000 Yield Equity, Options & Leveraged Equity - Text Example

15 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-15 Alcan Stock Price $45$55$65 All Stock$9,000$11,000$13,000 All Options$0$10,000$30,000 Lev Equity $9,270$10,270$12,270 Equity, Options & Leveraged Equity - Payoffs

16 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-16 Alcan Stock Price $45$55$65 All Stock-10.0%10.0% 30% All Options-100% 0% 200% Lev Equity -7.3%-2.7%27.7% Equity, Options & Leveraged Equity - Returns

17 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-17 Summary Reminder  Objective: This chapter is an introduction to the option markets. Options’ investment characteristics Option strategies Put-Call parity relationship Option-like securities and exotic options

18 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-18 Protective Put Use - limit loss Position - long the stock and long the put PayoffS T X Stock S T S T Put X - S T 0

19 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-19 Protective Put Profit STST Profit - P Stock Protective Put Portfolio

20 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-20 Covered Call Use - Some downside protection at the expense of giving up gain potential Position - Own the stock and write a call PayoffS T X Stock S T S T Call 0 - ( S T - X)

21 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-21 Covered Call Profit STST Profit -P Stock Covered Call Portfolio

22 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-22  Straddle (Same Exercise Price) Long Call and Long Put  Spreads - A combination of two or more call options or put options on the same asset with differing exercise prices or times to expiration Vertical or money spread Same maturity, different exercise price Horizontal or time spread Different maturity dates Option Strategies

23 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-23 Summary Reminder  Objective: This chapter is an introduction to the option markets. Options’ investment characteristics Option strategies Put-Call parity relationship Option-like securities and exotic options

24 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-24 S T X Payoff for Call Owned 0S T - X Payoff for Put Written-( X - ST) 0 Total Payoff S T - X S T - X Put-Call Parity Relationship

25 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-25 Long Call Short Put Payoff Stock Price Combined = Leveraged Equity Payoff of Long Call & Short Put

26 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-26  Since the payoff on a combination of a long call and a short put are equivalent to leveraged equity, the prices must be equal. C - P = S 0 - X / (1 + r f ) T  If the prices are not equal arbitrage will be possible Arbitrage & Put Call Parity

27 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-27 Stock Price = 110 Call Price = 17 Put Price = 5 Risk Free = 10.25% Maturity =.5 yr X = 105 C - P > S 0 - X / (1 + r f ) T 17- 5 > 110 - (105/1.05) 12 > 10  Since the leveraged equity is less expensive, acquire the low cost alternative and sell the high cost alternative Put Call Parity - Disequilibrium Example

28 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-28 Put-Call Parity Arbitrage ImmediateCashflow in Six Months PositionCashflowS T 105 Buy Stock-110 S T S T Borrow X/(1+r) T = 100+100-105-105 Sell Call+17 0-(S T -105) Buy Put -5105-S T 0 Total 2 0 0

29 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-29 Summary Reminder  Objective: This chapter is an introduction to the option markets. Options’ investment characteristics Option strategies Put-Call parity relationship Option-like securities and exotic options

30 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-30 Option-like Securities  Callable Bonds  Convertible Securities  Warrants  Collateralized Loans

31 Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 17-31 Exotic Options  Asian Options  Barrier Options  Lookback Options  Currency Translated Options  Binary Options

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