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Mechanics of Options Markets Chapter 9, 7 th edition Chapter 8, pre 7 th edition

Mechanics of Options Markets Chapter 9, 7 th edition Chapter 8, pre 7 th edition. Types of Options. A call is an option to buy A put is an option to sell A European option can be exercised only at the end of its life An American option can be exercised at any time

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Mechanics of Options Markets Chapter 9, 7 th edition Chapter 8, pre 7 th edition

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  1. Mechanics of Options MarketsChapter 9, 7th editionChapter 8, pre 7th edition

  2. Types of Options • A call is an option to buy • A put is an option to sell • A European option can be exercised only at the end of its life • An American option can be exercised at any time • Expiration = Exercise = Maturity date • Exercise = Strike price • http://www.m-x.ca/nego_cotes_en.php?symbol=ECA*&image.x=14&image.y=14

  3. Payoff Payoff K K ST ST Payoff Payoff K K ST ST Types of Options • A call is an option to buy (profit/payoff profile) • A put is an option to sell (profit/payoff profile)

  4. Option Positions • Two sides to every option contract • long = buy position • short = sell position • Four types of option positions • Terminal payoff characterization • Long call = max (St – K, 0) • Short call = min (K – St, 0) • Long put = max (K – St, 0) • Short put = min (St – K, 0)

  5. Assets Underlying Options • Stocks • Foreign Currency • Stock Indices • Futures

  6. Stock Options • Most trading in stock options is on exchanges • US: Chicago Board Options Exchange, Philadelphia Stock Exchange, American Stock Exchange, Pacific Exchange • Canada: Montreal Exchange • One options contract = 100 shares

  7. Foreign Currency Options • Most trading in foreign currency options is on over-the-counter and some exchange trading • US: Philadelphia Stock Exchange • Canada: Montreal Exchange • Size of contract depends on currency

  8. Index Options • Trading in both over-the-counter and exchange traded market • US: S&P 500 Index, Nasdaq 100 Index, Dow Jones Industrial Index • Canada: TSX 60 (http://globeinvestor.com/) • One options contract = 100 * Index • Flex options: traders on the floor agree to nonstandard terms on equities and indices (similar to over-the-counter contracts)

  9. Specification ofExchange-Traded Options • Expiration date • Strike price • European or American • Numerous expiration dates and strike prices • Option class (call or put) • Option series (same class, expiration date and strike price)

  10. Terminology Moneyness : • At-the-money option • In-the-money option • Out-of-the-money option

  11. Terminology(continued) • Intrinsic value • Time value • What is the time value on the expiration date? • Can intrinsic value be negative? • What is the intrinsic value for out-of-the money calls?

  12. Market Makers • Most exchanges use market makers to facilitate options trading; they add liquidity • 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 • Offer is always higher than the bid (bid-offer spread); exchange sets the upper limits for the bid-offer spread • http://www.m-x.ca/f_publications_en/mainteneurs_marche_en.pdf

  13. Offsetting Orders • An investor can close out a position by issuing an offsetting order • Commission system on options will make investors to sell rather than exercise options; commission paid when you purchase and sell

  14. Today T = 90 days Offsetting orders review Source: http://www.cboe.com/LearnCenter/OptionCalculator.aspx

  15. Tomorrow T = 89 days

  16. Tomorrow T = 89 days, Equity Price = $60

  17. Margins • Margins are required when options are sold without a position in the underlying stock Example on page 195 (read at home)

  18. Regulation • US: Options Clearing Corporation (OCC) • Canada: Canadian Derivatives Clearing Corporation (CDCC) • http://www.m-x.ca/participants_liste_en.php?specifique=1 • http://www.m-x.ca/nego_cotes_fr.php?symbol=LCE • http://www.m-x.ca/nego_liste_en.php • http://www.m-x.ca/produits_options_actions_en.php

  19. 5th and 6th edition: 8.1, 8.2, 8.9, 8.10, 8.125th edition only: 8.236th edition only: 8.227th edition only: 9.1, 9.2, 9.9, 9.10, 9.12, 9.22

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