Professional Documents
Culture Documents
Financial Options
Financial Options
FINANCE
Instructor:
Dr. Kumail Rizvi
OPTIONS
OPTIONS
TYPES OF OPTION
NOTATION
European call
option price
C:
p:
European put
option price
P:
S0:
ST:
K/X:
Strike price
T:
Life of option
D:
s:
Volatility of stock
price
PV of dividends paid
during life of option
c:
OPTION POSITIONS
Long call
Long put
Short call
Short put
LONG CALL
Profit from buying one European call option: option
price = $5, strike price = $100, option life = 2 months
20
10
0
-5
70
80
90
100
Terminal
stock price ($)
110 120 130
30 Profit ($)
SHORT CALL
Profit from writing one European call option: option
price = $5, strike price = $100
5
0
-10
-20
-30
80
90 100
Terminal
stock price ($)
Profit ($)
LONG PUT
Profit from buying a European put option: option price
= $7, strike price = $70
20
10
0
-7
Terminal
stock price ($)
40
50
60
70
80
90 100
30 Profit ($)
SHORT PUT
Profit from writing a European put option: option price
= $7, strike price = $70
7
0
-10
-20
-30
40
50
Terminal
stock price ($)
60
70
80
90 100
Profit ($)
K
K
ST
Payof
f
ST
Payoff
K
K
ST
ST
Payoff
ASSETS UNDERLYING
EXCHANGE-TRADED OPTIONS
Kumail Rizvi, PhD,CFA, FRM
Stocks
Foreign Currency
Stock Indices
Futures
SPECIFICATION OF
EXCHANGE-TRADED OPTIONS
Kumail Rizvi, PhD,CFA, FRM
Expiration date
Strike price
European or American
Call or Put (option class)
TERMINOLOGY
At-the-money option
In-the-money option
Out-of-the-money option
Moneyness :
OPTION VALUE
Higher the interest rate, it means the present value of strike price is less,
so the prob. of positive payoff is larger (S X), you need less increase in
price to make your payoff positive.
Higher the interest rate, the present of strike price will be less, so the prob.
of positive payoff is less (X S), you need much fall in price to make your
payoff positive.
SUMMARY
EXAMPLE:
SOLUTION:
PUT-CALL PARITY
PUT-CALL PARITY
If the two positions are worth the same at the
end, they must cost the same at the beginning
This leads to the put-call parity condition
S + P = C + PV(E)
If this condition does not hold, there is an
arbitrage opportunity
Buy the low side and sell the high side
You can also use this condition to find the value
of any of the variables, given the other three
ARBITRAGE OPPORTUNITY
Call Price = $7.50
Put Price = $4.25
Exercise Price on Underlying = $100
Current Price of Underlying = $99
Risk Free Rate = 10 percent
Time to Expiration = Half a Year or 6 months
Requirements
BSM
S
1 2
ln( ) (r s )T
X
2
d1 =
s T
d2 = d1 - ss T