Lecture 6 - Mechanics of option markets Flashcards
Explain why margin accounts are required when clients write options but not when they buy
options.
When an investor buys an option, cash must be paid upfront. There is no possibility of future liabilities and therefore no need for a margin account. When an investor sells an option, there are potential future liabilities. To protect against the risk of default, margins are required.
“Employee stock options issued by a company are different from regular exchange-traded
call options on the company’s stock because they can affect the capital structure of the
company.” Explain this statement.
The exercise of employee stock options usually leads to new shares being issued by the company and sold to the employee. This changes the amount of equity in the capital structure. When a regular exchange-traded option is exercised no new shares are issued and the company’s capital structure is not affected.
A corporate treasurer is designing a hedging program involving foreign currency options.
What are the pros and cons of using (a) the NASDAQ OMX and (b) the over-the-counter
the market for trading?
The NASDAQ OMX offers options with standard strike prices and times to maturity. Options in the over-the-counter market have the advantage that they can be tailored to meet the precise needs of the treasurer. Their disadvantage is that they expose the treasurer to some credit risk. Exchanges organize their trading so that there is virtually no credit risk. In addition, liquidity issues can vary between these two markets.
