CH 10 Hull OFOD9 TH Edition

Chapter 10
Mechanics of Options
Markets
Options, Futures, and Other Derivatives, 9th Edition,

Copyright © John C. Hull 2014 1
Review of Option Types

Review of Option Types
(continued)

Option Positions

Long Call (Figure 10.1, Page 214)
Profit from buying one European call option: option
premium= $5, strike price = $100, option life = 2
30 Profit ($)
months
20 Π = Max(0,ST – X) – c0
10 Terminal
70 80 90 100 stock price ($)
0
-5 110 120 130
5
If I buy a call option when
would it be advantageous to
exercise the option?
Π = Max(0,ST – X) – c0
X=100
c0=5
If the ST >105 (the wrong answer)
If the ST >100 (the correct answer)

Cont
Π = Max(0,101 – 100) – 5
=Max(0,1) – 5
=1-5=-4
It is appealing to think that the call option should not
be exercised unless it is profitable i.e. Π>0 that is
ST>105. However, the matter of the fact is that we
have already paid $5 as a price for the call option
(premium) so if the price ST exceeds $100, then the
call should be exercised in order to recoup at least a
part of the paid premium.
Short Call (Figure 10.3, page 216)
Profit from writing one European call option: option
price = $5, strike price = $100
Profit ($)
5 110 120 130
0
70 80 90 100 Terminal
-10 stock price ($)
-20
-30
Long Put (Figure 10.2, page 215)
Profit from buying a European put option: option
price = $7, strike price = $70
Π = Max(0,X – ST) – p0
30 Profit ($)
20
10 Terminal
stock price ($)
0
40 50 60 70 80 90 100
-7

Short Put (Figure 10.4, page 216)
Profit from writing a European put option: option price
= $7, strike price = $70
Profit ($)
Terminal
7
40 50 60 stock price ($)
0
70 80 90 100
-10
-20
-30
Payoffs from Options (intrinsic
value
What is the Option Position in Each Case?
X = Strike price, ST = Price of asset at maturity
Payoff Payoff
X
X=ST ST ST
Payoff
Payoff
X
X ST ST

Assets Underlying
Exchange-Traded Options
Page 217-218
Stocks
Foreign Currency
Stock Indices
Futures

Specification of
Exchange-Traded Options
Expiration date
Strike price
European or American
Call or Put (option class)

Terminology
Moneyness :
At-the-money option
In-the-money option
Out-of-the-money option

Terminology
(continued)
Option class
Option series
Intrinsic value
Time value

Ways the CBOE Is Trying to Take
Market Share from the OTC Market
Flex options
Binary options
Credit event binary options (CEBOs)
Doom options
Not examinable

Market Makers
Most exchanges use market makers to
facilitate options trading
A market maker quotes both bid and ask
prices when requested
The market maker does not know whether the
individual requesting the quotes wants to buy
or sell

Margins (Page 224-226)
Margins are required when options are sold
When a naked option is written the margin is the
greater of:
A total of 100% of the proceeds of the sale plus
20% of the underlying share price less the
amount (if any) by which the option is out of the
money
A total of 100% of the proceeds of the sale plus
10% of the underlying share price (call) or
exercise price (put)
For other trading strategies there are special rules
Not examable
Warrants
Warrants are options that are issued by a
corporation or a financial institution
The number of warrants outstanding is
determined by the size of the original issue
and changes only when they are exercised
or when they expire

Warrants
(continued)
The issuer settles up with the holder
when a warrant is exercised
When call warrants are issued by a
corporation on its own stock, exercise
will usually lead to new treasury stock
being issued

Employee Stock Options (see also Chapter 16)
Employee stock options are a form of
remuneration issued by a company to its
executives
They are usually at the money when issued
When options are exercised the company
issues more stock and sells it to the option
holder for the strike price
Expensed on the income statement
Convertible Bonds
Convertible bonds are regular bonds that can
be exchanged for equity at certain times in
the future according to a predetermined
exchange ratio
Usually a convertible is callable
The call provision is a way in which the issuer
can force conversion at a time earlier than the
holder might otherwise choose
Not examinable

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Chapter 10

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

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