1. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 1 Chapter 2: The Structure of Options Markets If the financial markets are a war zone, this is the theater of hand-to-hand combat. Richard Thomson Apocalypse Roulette, 1998, p. 49

2. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 2 Important Concepts in Chapter 2 n Definitions and examples of call and put options n Institutional characteristics of options markets n Options available for trading n Placing an options order n The clearinghouse n Accessing option price quotations n Transaction costs n Regulation of options markets n Margins and taxes in option transactions

3. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 3 Option terminology u price/premium u call vs. put u exercise price/strike price/striking price u expiration date Everyday examples of options u rain check u discount coupon u airline ticket with cancellation right u right to drop a course

4. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 4 The Development of Options Markets n Early origins n Put and Call Brokers and Dealers Association n Chicago Board Options Exchange, 1973 n Resurgence of over-the-counter market

5. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 5 Call Options n Current example n Objective of a call buyer n Moneyness concepts u In-the-money u Out-of-the-money u At-the-money

6. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 6 Put Options n Current example n Objective of a put buyer n Moneyness concepts u In-the-money u Out-of-the-money u At-the-money

7. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 7 The Over-the-Counter Options Market n Worldwide n Credit risk n Customized terms n Private transactions n Unregulated n Options on stocks and stock indices, bonds, interest rates, commodities, swaps & currencies

8. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 8 Organized Options Trading n Listing Requirements n Contract Size n Exercise Prices n Expiration Dates n Position and Exercise Limits The concept of an options exchange

9. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 9 Options Exchanges and Trading Activity n See Table 2.1, p. 29 for options exchanges Table 2.1, p. 29Table 2.1, p. 29

10. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 10 Option Traders n The Market Maker u Bid, ask, and bid-ask spread u Scalpers, position traders, spreaders n The Floor Broker u Designated primary market makers u Dual trading n The Order Book Official u Limit orders u Electronic order processing

11. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 11 Options Traders (continued) n Other Option Trading Systems u Specialists u Registered options traders u Electronic trading systems n Off-Floor Option Traders n Cost and Profitability of Exchange Membership u See Figure 2.1, p. 32 for CBOE seat prices Figure 2.1, p. 32Figure 2.1, p. 32 u Leasing a seat u High risk, stressful work

12. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 12 The Mechanics of Trading n Placing an Opening Order u Types of orders n The Role of the Clearinghouse u The Options Clearing Corporation (OCC) u Clearing firms u See Figure 2.2, p. 34 Figure 2.2, p. 34Figure 2.2, p. 34 u Margin (see Appendix 2.A) u Open interest

13. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 13 The Mechanics of Trading (continued) n Placing an Offsetting Order u In the exchange-listed options market u In the over-the-counter options market n Exercising an Option u European vs. American style u Assignment u Cash settlement

14. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 14 Option Price Quotations n See web sites of newspapers and options exchanges n Problems u Delayed information u Nonsynchronized prices

15. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 15 Types of Options n Stock Options n Index Options n Currency Options n Other Types of Traded Options u interest rate options u currency options u options attached to bonds u exotic options u warrants, callable bonds, convertible bonds u executive options n Real Options

16. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 16 Transaction Costs in Option Trading n Floor Trading and Clearing Fees n Commissions n Bid-Ask Spread n Other Transaction Costs

17. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 17 The Regulation of Options Markets u Federal regulation u Industry regulation u Over-the-counter market regulation u The issue of which agency has regulatory responsibility has occasionally arisen. Summary

18. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 18 Appendix 2.A: Margin Requirements n Definitions u Margin u Initial margin u Maintenance margin n Margin Requirements on Stock Transactions n Margin Requirements on Option Purchases n Margin Requirements on the Uncovered Sale of Options n Margin Requirements on Covered Calls

19. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 19 Appendix 2.B: Taxation of Option Transactions n Taxation of Long Call Transactions n Taxation of Short Call Transactions n Taxation of Long Put Transactions n Taxation of Short Put Transactions n Taxation of Non-Equity Options n Wash and Constructive Sales

20. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 20 (Return to text slide)

21. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 21 (Return to text slide)

22. D. M. ChanceAn Introduction to Derivatives and Risk Management, 6th ed.Ch. 2: 22 (Return to text slide)