Chapter 2 Flashcards
the price at which an option holder can buy or sell the underlying asset
strike or exercise price
Types of options contract
Call option
Put Option
grants the right to purchase a share of stock at a fixed price on or before a certain date
Call option
Grants the right to sell a share of stocks at a fixed price on or before a certain date
Put option
is a contract between two parties, neither of
whom need have any connection to the company
whose stock serves as the underlying asset for the
contract
Option
are not necessarily issued by firms.
Options
Options trade either on an
exchange or over the counter market
as the price an investor would be willing to pay for the option of the instant before it expires.
Options payoff
is distinct from it’s price, or premium, because the payoff only refers to the price of the option at a particular instant in time, t he expiration date.
Options payoff
refers to the profit or loss an option buyer or seller makes from a trade.
Call option payoff
A graph that illustrates an option’s payoff as a function of the underlying stock price.
Payoff Diagrams
These diagrams are extremely useful tools for underrated how options behave and how they can be combined to form portfolios with fascinating properties.
Payoff Diagrams
is the right,
but not the obligation
Put option
to sell an asset at a pre specified price on, or before, a pre specified date in the future.
Put Option
The concept of combining call and put options to create portfolios with unique payoff structures.
Payoffs for Portfolios of Options and Other Securities
The graphs illustrate the payoff scenarios for long and short positions in both common stock and risk free, zero coupon bonds.
Payoff Diagrams for Stocks and Bonds
This graph represents a portfolio that combines a long position in the underlying stock with a long position in a put option for that same stock, having a strike price of
Payoff from One Long Share
and One Long Put
Is a fundamental principle in options pricing and trading.
Put Call Parity
Option Pricing Models
The Binomial Model
The Black and Scholes Model
It is an options valuation method developed in 1979. The model assumes that stock price have two possible movement directions at each time point up or down.
The Binomial Model
Recognizes investors can combine options with shares of the underlying assets to construct a portfolio with an risk free payoff.
The Binomial Model
Three steps of binomial model:
- Create a risk free portfolio
- Calculate the present value of portfolio
- Determine the price of the option
aka the Black Scholes Merton (BSM) model, is a differential equation widely
The Black Scholes model
is a differential equation widely
used to price options contracts.
The Black-scholes Model
five input variables of black scholes model
The Strike price of an option
The Current stock price
The Time to expiration
the risk-free rate
the volatility
and where:
S
X
t
r
o
e
N(X)
S = current market price of underlying stock
X = strike price of option
t = amount of time (in years) before option expires
r = annual risk
free interest rate
o = annual standard deviation of underlying stock’s returns
e = 2.718 (approximately)
N(X) = the probability of drawing a value less than or equal to X
from the
are essentially call options that give employees the right to buy shares in the company they work for at a fixed price.
Employee Stock Options
requires firms to treat the value of employee stock options grants as an expense on the
income statement.
Financial accounting standards board
are securities that are issued by firms and that grant investors the right to buy shares of stock at a fixed price, for a given period of time.
- Warrants
Are contract investors who are not necessarily connected to the firm whose stock serves as the underlying asset
Call options
- When investors are exercise warrants, the number of outstanding shares
increase and the issuing firm receives the ???? as a capital inflow.
strike price
are often issued with expiration dates that are several years in the future
Warrants
expire in just a few months
Options
A bond that gives investors the right to convert their bonds into shares.
Convertible bond
The market price of a convertible bond, divided by the number of shares of stock that bondholders receive if they convert.
Conversion Price
The number of shares bondholders receive if they convert their bonds into shares.
Conversion Ratio
The percentage increase in the underlying stock that must occur before it is profitable to exercise the option to convert a bond into shares.
Conversion Premium
The market price of the stock, multiplied by the number of shares of stock that bondholders receive if they convert.
Conversion Value
