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FINA3204 03 Options Basics
FINA3204 03 Options Basics
FINA 3204
Options Basics
Course Overview
Forwards &
Futures
Market
Mechanics
Hedging
Strategies
Options
Pricing
Market
Mechanics
Properties
Trading
Strategies
Pricing
Binomial
Tree
Greeks
Black-Scholes
Other Derivatives
Warrants, CBBC
Swaps
Convertible
Bonds
Structured
Products
Payoff
K
K
ST
ST
K
K
ST
ST
max( 0, ST K )
- max( 0, ST K )
Long Put:
Short Put:
max( 0, K ST )
- max( 0, K ST )
Terminology
Moneyness
At-the-money option (ATM)
In-the-money option (ITM)
Out-of-the-money option (OTM)
Intrinsic Value
The value derived from the options moneyness
Time Value
The part of option value that is in excess of its
intrinsic value
The Hong Kong University of
Science and Technology
Margin
Margins are required only when options are
written
Hong Kong Stock Option Margin Requirements:
http://www.hkex.com.hk/eng/sorc/margin_data/margin_data
_search.aspx
Options Exchanges
U.S.
CBOE (major options exchange)
CME Group (futures options)
Asia-Pacific
HKEX
http://www.hkex.com.hk/eng/prod/drprod/so/classlist_so.htm
Notations
c:
C:
p:
P:
S0:
ST:
K:
Strike price
T:
Life of option
D:
s:
Volatility of stock
price
PV of dividends paid
during life of option
S0
+ (no div)
? (with div)
c S0
C S0
p Ke rT
PK
Lower Bounds
c max( S0 Ke -rT , 0 )
p max( Ke -rTS0, 0 )
The Hong Kong University of
Science and Technology
Cc
Pp
FINA 3204: Derivative Securities
Andrew Chiu
S0 = 20
T=1
r = 10%
K = 18
D=0
S0 = 37
r = 5%
K = 40
D =0
Payoff
50
40
30
20
10
0
0
10
20
30
40
50
Stock Price at Expiration
60
Payoff
20
10
0
-10
-20
-30
-40
10
20
30
40
50
Stock Price at Expiration
60
Payoff
25
20
15
10
5
0
0
10
20
30
40
50
Stock Price at Expiration
60
S0= 31
T = 0.25
K =30
r = 10%
D=0
Effects of Dividend
Lower Bounds
c + Ke -rT = p + S0 PV(D)
The Hong Kong University of
Science and Technology
Ex-Dividend Date
Stock
S=100
S = 99, Div = 1
c =9.20
S = 99
Div = 1
Loss = -0.30 (better to exercise)
Dont Exercise
Cost of call: -10.30
C = 9.30
Loss: -1
S = 99
Div = 1
Loss = -2
Dont Exercise
Cost of call: -12
C = 11
Loss = -1 (better NOT exercise)
c > S Div K
Dividend Capture
Buy stock and Sell in-the-money calls to capture dividend
when the counterparty does not exercise the call.
Assume rf = 0
S = 100
American Call (X=90)
Suppose C = 10
Counterparty Exercises:
Ex-Dividend Date
Profit = 0
S=99, Div=1
C=9
Buy back call: -9
Sell stock: +99
Receive Dividend: +1
Profit = +1
Even if S deviates from 99 by small
amounts, the profit is still +1