You are on page 1of 19

CFA Institute

Fact and Fantasy in the Use of Options Author(s): Fischer Black Source: Financial Analysts Journal, Vol. 31, No. 4 (Jul. - Aug., 1975), pp. 36-41+61-72 Published by: CFA Institute Stable URL: http://www.jstor.org/stable/4477843 . Accessed: 23/09/2011 16:08
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial Analysts Journal.

http://www.jstor.org

The big unknown in the option formula is the volatility of the underlying stock. Footnotes appear on page 72. so it will be easy to see the effects of changes in any one of the four inputs other than the exercise price. and the option value. that covered option writers almost always gain more than they lose by writing options. and some of which have not yet appeared in final form. But the volatility of the stock must be estimated. in terms of the stock.2 It will make use of several refinements and extensions of the formula. . Fenner & Smith. there is a fantasy-a reason given for trading or not trading in options that doesn't make sense when examined carefully. The simplest version of the Fischer Black is Professor of Finance. University of Chicago. Note that the value of an option for a given stock price does not depend on what the stock is expected to do. Inc. and factors other than past volatility can be helpful in predicting it. and downplays the possible loss of appreciation on the stock if the option is exercised. The time to maturity and the exercise price are known. 36 0 FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 formula assumes that the short-term interest rate and the volatility of the stock never change. An investor who thinks the stock will go up will think both the stock and the option are underpriced. such as the fact that the brokerage charge for taking a position in options can sometimes be lower than the charge for taking an equivalent position directly in the underlying stock.' There are some good reasons for the growing popularity of options trading. The past volatility of the stock is very helpful in estimating its future volatility. This article aims at separating fact and fantasy. but is not an infallible guide.) at the University of Chicago.by Fischer Black Fact and Fantasy In the Usec: of Options Options trading is where the action is in the securities markets these days. for example. The tables in Appendix B show the values of an option with a $40 exercise price according to the formula. He wishes to thank Myron Scholes and Robert Merton for extensive discussions on these issues. (2) the time to maturity. It is sometimes said. as an option on a stock that is expected to go down. The values for an option with an exercise price other than $40 can be obtained by making proportional changes in the stock price. If the price of an option on an exchange is higher than its value. then an investor who holds the 1. Thus there are five numbers we need to calculate an option value: (1) the stock price. The stock price and the interest rate can be observed. and Paul Blair. careful study shows that an investor who writes call options against his stock will often end up with a worse position than the one he started with. The option values are arranged in three different ways. (4) the interest rate. Graduate School of Business. the exercise price.3 The Option Formula The option formula (shown in Appendix A) gives the value of a call option for any stock price and time to maturity. But for every fact about options. (3) the exercise price. and of the kind of analysis that led to the formula. and if the formula is giving the correct value. some of which have been published. Pierce. This statement focuses on the premium income. It will make heavy use of the option formula developed by Black and Scholes. James Dalton and Joseph Williams for comments on an earlier draft. The volatility of a stock can change over time. An option on a stock that is expected to go up has the same value. This work was supported in part by the Center for Research in Security Prices (sponsored by Merrill Lynch. and that the stock pays no dividends. and (5) the volatility of the stock. In fact. An investor who thinks the stock will go down won't buy either the stock or the option.

and an investor who doesn't hold the option should write it. And finally. Then the value of two options is $10. they will bring gains or losses on a fixed hedged position. Suppose.00. Changes in the stock price and in time to maturity cause changes in the option position that is equivalent to a stock position. We look down a single column at the values of the option for different stock prices. the writer is likely to gain and the buyer is likely to lose. we compare two different entries in the same table. In Appendix B. In other words. This is true of the writer's options position whether or not he owns the underlying stock. and selling three option contracts gives the same action as shorting one round lot of stock.option should sell it. The hedge ratio is the ratio of stock to option needed for a neutral hedge. If the investor wants a short position. If it is underpriced when it is written. If the price of an option on an exchange is lower than its value.buy it. and the writer's losses are the buyer's gains. these factors do not always favor options. The investor may have to put up less capital to take an equivalent option position. When the option is way in the money. If it takes ten $100 option contracts to get the equivalent of one round lot of stock. That means that the option value goes up or down about $0.4 The gains or losses on the long position will be offset by losses or gains on the short position.. whether he holds the underlying stock or not. the commission on the ten contracts is $85.e. However. while the value of one stock is $40. Sometimes it's better for an investor who wants a position in the stock to take it directly. the writer is likely to lose and the buyer is likely to gain. sell it.33 at a given point in time. the value of the long position need not equal the value of the short position. Then a position that is short two options and long one stock or long two options and short one stock will change in value very little when the stock goes up or down $1. For equivalent dollar action. it may be better to deal in the option. then an investor who doesn't hold the option should buy it. and if the formula is giving the correct value. If the option is underpriced. Because large moves in the stock tend to alter the hedge ratio. the rules for an option buyer are the same as the rules for an option writer. and this can be important if he has limited capital. So the fact that multiple option contracts are often FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 O 37 . This is true for both buyer and seller. So an investor who wants the action on a stock has two ways of getting it.50. for very small changes in the stock price. For small moves in the stock over a short period of time. or he can deal in the option.00. His premium income on an underpriced option will be more than offset by his expected losses due to a possible increase in the price of the option over its life. The values of the two sides of the position are not even close. suppose the hedge ratio is 0. The hedge ratio tells how to set up a "neutral hedge" between the option and the stock. To see the effects of larger changes in the stock price. The writer's gains are the buyer's losses. however. If the commission on an equivalent option position is less than the commission on the stock. the number of option contracts needed for a position equivalent to one round lot of stock goes down. As the stock price goes up. For example. under the current commission schedule. A neutral hedge is one that is fow in risk for small moves in the stock. In a neutral hedge. it may take only one contract to give a position equivalent to one round lot. that the option price is $5 and the stock price is $40. He can deal directly in the stock. The hedge ratio tells what that position is. If the hedge ratio is 0. But the commission on one round lot of a $40 stock would be about $60. If the option is underpriced-i. he can buy it for less than the formula says it's worth-then it may be better to buy the option than to buy the stock. because he may get interest on the proceeds of the sale of options. it may take ten contracts to give a position equivalent to one round lot. it is often better to sell naked calls than to short the stock. in the above example. Option versus Stock The value of an option is closely related to the price of its underlying stock. and an investor who has written the option should buy it back. If an option is overpriced when it is written. Buying three option contracts gives the same action (for small price moves in the short run) as buying one round lot of stock. he usually has to take a larger share position in the option than he would take in the stock. the hedge ratios appear in parentheses. and sometimes it's better for him to take it via the option. then three options will give the same action (in dollars) as one share of stock. When the position is way out of the money. If the option is overpriced. there may be tax reasons for dealing in the option instead of the stock. under the option values. An option writer will generally lose if he writes underpriced options. there is a position in the option that will give almost the same action (in dollars) as a position in the stock.50 when the stock goes up or down $1. The hedge ratio is the ratio of the change in the option value to the change in the stock price.

then the "net money" in a stock position is always more than the net money in an equivalent option position. Writing options against a stock position gives the equivalent of a long position in the stock. but is surely a more conservative strategy.5 This means that the alternative to a long stock position is a mixture of long option positions and short-term money market instruments. it will do better than the stock position for large moves in the stock price. "If you want to make a fast buck. If a long position in two option contracts is equivalent in the short run to a long position in 100 shares of stock. In the short run. In the short run. And in the long run. the option position will go down a maximum of $1.000.000 in certificates of deposit. the risk in the two positions is the same. and worse than the stock position if the stock price remains about the same.needed to get the equivalent of a given stock position can make the option commissions higher than stock commissions. and will end up with a higher value than the stock position. In the long run. But the short option position will do worse than the equivalent short stock position if the stock goes way up or way down and the option position is left unchanged. then a position with 100 shares of stock long and one option contract short will be equivalent to a long position in only 50 shares of stock. the investor might pay $1.000 for two option contracts. If buying options is less speculative than buying an equivalent amount of stock. and if the hedge ratio is used to set up an equivalent position. A position with one round lot of stock long and one option contract short is less risky in the short run than a position with just the one round lot of stock. If options are priced according to the formula. and the option position will be down $1. and put the remaining $3. In the long run. if the option position is not changed.000 for 100 shares of a $40 stock. the option position may go up or down just about the same amount as the stock position.000. An investor who is long 100 shares of stock and short one option contract has a position that will go up in value if the stock goes up. if the hedge ratio is 0. Tobey. and down in value if the stock goes down. just go in and tell them you want to make a fast buck. This position can be compared with the two alternatives we have already discussed: a position in the underlying stock without option writing. then writing 38 0 FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 naked options is more speculative than shorting an equivalent amount of stock. while the stock position can go down any amount up to $4. The New Yorker Magazine.8 If options are priced according to the formula.For example.7 Writing Options Writing naked call options compared with shorting the stock is like buying call options compared with buying the stock. then a short position in options will give the same gains or losses in the short run as the equivalent short position in stock. Thus the following positions are equivalent in the short run. And if the stock goes way down.? 1958 Inc.50: (1) a position that is long 100 shares of stock lF MEMI1tI Et by Drawing B. If the stock ends up at the exercise price. the option position will start moving up twice as fast as the stock position. instead of putting up $4. the short option position will do better than the short stock position if the stock doesn't move much.6 Thus an appropriate mixture of a long position in options with short-term money market instruments is less speculative from almost any point of view than an investment in the underlying stock." .000. the option will expire worthless. the option position comes out ahead for large moves in the stock in either direction. The right mixture of options and CD's has the same expected return as the corresponding stock position. But if the stock goes way up. and a long position in the option.

it may become important to avoid the more speculative positions. and (3) $3000. just divide the two hedge ratios. and (3) $500.500 and the net money (if any) in CD's. If the hedge is long stock and short options.33. But if the stock has a large move. or short the stock and long the options.500. so the investor should increase his stock position by 50 per cent.000. and the smaller the range of stock prices for which the hedge will end up unprofitable. (2) $1500. so the investor should double his stock position and write overpriced calls on all of it. then writing options against a stock position cuts its exposure by a third. If the hedge is long options and short stock. It does not make sense when the calls are underpriced. A "money spread" involves buying an option at one striking price and selling an option at another striking price. the larger the range of stock prices for which the hedge will end up profitable. He will come out behind if the stock moves a lot.The fact that one position is more "speculative" than another is not important in most cases. Assuming that the stock price is $40 and the option price is $5. To see what happens to the equivalent positions in the long run. Writing options against a stock position is speculative because this strategy does worse for large moves in the stock than alternative strategies that have equivalent exposure to the action in the stock for small moves in the stock. the investor who buys stock and writes options will lose everything. the first is the most speculative (writing covered options) and the last is the least speculative (buying options and CD's). then writing options against a stock position cuts its exposure in half. The hedge ratio tells how much more stock to buy. both on the same stock with the same striking price. he ends up better off than if he went to an equivalent position by selling some of his stock. and the investor who buys options and CD's will end up with $3.and short one option contract. and if an investor writes an option against stock at that price. If the hedge ratio is 0. and then write overpriced calls on all of it. It is not correct to say that an investor can increase his rate of return by writing call options against his stock. he is making a fair deal. If the stock goes to zero. or selling an option in the middle and buying one on each side. When a large loss would lead to lawsuits and other complications. both on the same stock and with the same maturity. More complicated spreads are possible too. The only way a writer can improve expected return and retain the same exposure to small stock movements is to buy more stock and write overpriced options against his total stock position. Another way to use options is to spread options against one another. To find the right ratio. Writing calls makes sense when the calls are overpriced. we can assume that the investor puts up $3. A "time spread" or "calendar spread" involves buying an option at one maturity and selling one at another." because he creates a position that is equivalent to selling some of his stock.500 plus interest. and invests the difference between $3. In fact. The hedge ratios on two options tell how to create a neutral spread between them. If an investor writes options against his stock position and the stock doesn't move. If the hedge ratio is 0. the investor who buys stock and CD's will end up with $1. Thus the investment in CD's in each case is: (1) zero.33. He creates a position in which he will come out ahead only if the stock doesn't move very much. Of these three positions. Writing overpriced calls against a stock position makes just as much sense as buying underpriced calls for most investors. A "butterfly spread" involves buying an option in the middle (in terms of either striking price or time) and selling one on each side. and (3) a position that is long one option contract. When the option is overpriced. These three positions involve different amounts of net money. (2) $2. (2) a position that is long 50 shares of stock. His possible gains if the stock stays at about the same price are just offset by his possible losses if the stock makes a wide move (relative to selling some of his stock instead). the net money involved in each position is: (1) $3. For FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 O 39 .000 plus interest. If the formula gives the correct price for an option. it will show gains for small moves in the stock and losses for large moves in the stock in either direction.500. The investment in CD's is the limit on the amount the investor can lose.9 When the option is underpriced. If the hedge ratio is 0.then the way to hedge is to go long options and short stock. he ends up worse off than if he went to an equivalent position by selling some of his stock. he reduces his "expected return. then a neutral hedge will be three option contracts against one round lot of stock. the way to hedge is to go long stock and short options. A neutral hedge is neither bullish nor bearish. The farther out of line the option is. It becomes important when a large loss has more serious consequences than loss of the money. it will show losses for small moves in the stock and gains for large moves in the stock in either direction. A neutral hedge is achieved by going either long the stock and short the options.50. Hedging and Spreading One way to use options is to hedge options against stock.

If the value is less than the price. but not as high as the apparent volatility in the latest month.30. If we know that a company with a volatile stock is merging with a large. A stock that drops sharply in price is likely to show a higher volatility in the future (in percentage terms) than a stock that rises sharply in price. An increase in the estimated volatility for a stock will increase the values of all the options on the stock. The indicated spread will be the same in either case: short the October and long the January in an appropriate ratio. The direction of the price movement in a stock can also be used. the spread can be analyzed more exactly. it is possible that the market's estimate of its volatility is lower than the estimate used in the formula. the more speculative it is. Very large moves in the stock can be disastrous if the spread is not changed. If the volatility of a stock did not change. we would look as far back as possible. we may want to reduce our estimate of the future volatility of its stock. A position with one $60 option long and ten $80 options short has great exposure to potential large losses. his gains on the speculative spreads will help offset his losses on the conservative spreads. a spread that is long a more in-the-money option and short a more out-of-the-money option is speculative. If the latest month shows a sharp increase in volatility for stocks generally. so more weight should be given to recent months. Thus when the options on a stock seem generally overpriced. and would give as much weight to far distant months as to near months. With a 3:1 spread. it is possible that the "market'sestimate" of the volatility of the stock is higher than the estimate used in the formula. ourestimate for the future will be higher than it was. and loses money for large moves in the stock. and the hedge ratio on the corresponding Januaryoption is 0. A position with one January long and ten Octobers short has great exposure to potential large losses. This is particularly true when the spread ratio is high. when the long side is underpricedand the short side is overpriced. we multiply the value of the first option by three. if the hedge ratio on an October option is 0. Sometimes other kinds of information can be useful. Similarly.example. and subtract the result from the value of the second option. A spread that is short the near month and long a more distant month is speculative. (The other possibility is that the market is simply pricing the options incorrectly. Then we multiply the price of the first option by three.1G. or when the long side is more underpricedthan the short side. stable company. we may want to increase our estimate of the future volatility of its stock. then the estimated volatility on the other stock should be increased too. If an October option seems more overpriced than the correspondingJanuary. it makes sense to buy the first option and sell the second. it is likely that the October will seem less underpriced than the January. his gains on the conservative spreads will help offset his losses on the speculative spreads. If we know that a company is starting a risky new venture. and subtract the result from the price of the second option. and less weight should be given to distant months. If the latest month shows a sharp increase in the volatility of one of two stocks in the same industry. and if stocks generally don't move very much. This is the price of the spread. It makes sense for an investor who is working with spreads to try to have some that are speculative and some that are conservative. then a neutral hedge would involve three Octobers and one January. or when the long side is less overpriced than the short side. in the sense that it makes money for small moves in the stock. the volatility estimate implied by the general level of option prices on a stock should be given some weight in . Sharp increases and decreases in volatility are often only temporary. the more data we have to look at.and we increase the volatility estimate on the stock so that both now seem underpriced. 40 E FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 Estimating Volatility The volatility of a stock can be estimated by looking at the size of the typical change in the stock price from day to day. The greater the difference in the exercise prices. of course. an increase in the volatility estimate will increase the value of all the options on a stock. The farther back in time we look.) Since the market may know some things about the future volatility in the stock that we don't know. then it makes sense to increase our volatility estimate mQre for any given stock than we would if it were the only stock showing a sharp increase in volatility. This means that when a stock seems to have a sharp increase in volatility during a month. In estimating the volatility of a stock. it makes sense to sell the first option and buy the second. we can also use information on the price behavior of other stocks. Then if stocks generally move way up or way down. A spread makes sense. This is the value of the spread. Once the ratio of options in a spread has been figured. When the options on a stock seem generally underpriced. If the value is greater than the price. The analysis of a spread is less sensitive to the estimated volatility of the stock than the analysis of a hedge of option against stock. But the volatility does change.

but the fact that we are not subtracting the discounted value of the last dividend tends to increase it. if a dividend is due in three months and the interest rate is 12 per cent we discount the dividend by dividing it by about 1. To see the effects of a five percentage point change in the interest rate. Interest Rates The interest rate in the option formula is the rate on a very low risk note that matures at the time the option expires. On the other hand. The change in the option price will reflect all of these changes. If the option will be exercised only at maturity. For all dividends except the last one before the option expires. To get a rough idea of why this is so. Since the exercise price is a potential liability for the holder of an option. and times when most traded options seem overpriced. it can pay only if the annual dividend divided by the exercise price of the option is greater than the interest rate. It may be that the market is expecting volatilities to be generally lower or generally higher than the estimates used in the formula. In practice. If the volatility of a stock was unusually high in the latest month. Thus to figure the value of an option on a dividend-paying stock. we do two calculations of the value. We use this adjusted stock price instead of the actual stock price in the option formula.estimating the stock's future volatility. we might project a gradual decline in volatility back to more normal levels. The closer the last ex-dividend date is to the maturity date. we might project a continued increase in volatility for a time. The fact that we are using a shorter time to maturity tends to reduce the value of the option. Because there is a possibility that it will pay to exercise the option just before the last ex-dividend date.03. There are times when most traded options seem underpriced. a change in the interest rate will not occur by itself. Sometimes there should be a different volatility estimate for each option maturity. A one pecent fall in the price of a CD maturingat the same time as the option has the same effect as a one per cent reduction in the exercise price. and use the one that gives the higher value.03 because of the effects of compounding. when the stock pays no dividends. note that an increase in the interest rate reduces the present value of the exercise price. we will use it instead. there are two kinds of possible explanations for this. we can figure an alternative value of the option by assuming that it expires just before the last ex-dividend date. it pays to exercise an option just before it goes ex-dividend. An increase in the interest rate will have a larger effect on an option with long maturity than on an option with a short maturity. the less the option is worth." The first calculation subtracts the present value of all the dividends from the stock price. however. the more likely it is that exercise just before the ex-dividend date will make sense. the stock price usually falls. Dividends An option on a stock that pays a dividend is worth less than an option on an identical stock that pays no dividend. A one percentage point change in the interest rate does not generally have much effect on the value of an option. we can approximate the value of the option on a dividend paying stock by subtracting the present value of the dividends likely to be paid before maturity from the stock price. so it makes sense to use those rates as inputs to the option formula.'0 This condition is rarely satisfied. see Table 2 in Appendix B. The higher the dividend. This means that there normally will be a different interest rate for each different option maturity. values are affecting the option prices. the more likely it is that the effect of leaving off the last dividend will dominate the effect of reducing the time to maturity. When a stock goes ex-dividend. If this gives a higher value of the option than the first calculation. The rates on CD's and prime commercial paper are given separately for different maturities. Again. there may be a change in the stock price and a change in the volatility of the stock. But it often pays to exercise an in-the-money option just before the last ex-dividend date. The closer the last ex-dividend date is to the expiration date of the option. reducing the likelihood that the stock will be above its exercise price at maturity. Holding constant all the inputs to the option formula except the interest rate. The second calculation subtracts the present value of all divicontinuedon page 61 FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 cl 41 . hence the value of the option. or it may be that factors unrelated to option. an increase in the interest rate always increases the value of an option. Thus a change in the interest rate will change the relative values of near and far options. and uses the actual maturity date for the option. Over the same period. We get the present value of the dividends by discounting them at the interest rate we are assuming. An increase in the interest rate has the same effect as a reduction in the exercise price of an option. this increases the value of the option. For example.) Sometimes. (The number will differ slightly from 1. if the volatility of the stock has been increasing in recent months.

we would need exactly two. The writer of an option should decide whether to buy in before the last ex-dividend date on the same basis. we need to compare the spread for two option contracts with the spread for one round lot of stock. applies only to short-term trading.) The public commission on two option contracts with a premium of $500 for each contract is $37 one way. So he protects himself to some extent by quoting a lower price to those who want to sell and a higher price to those who want to buy. he may choose to deal in options when he feels he has an especially important piece of information. This means that the writer should decide whether he wants to close his position by buying in or by having the option exercised against him. The holder of an option should keep it beyond the last ex-dividend date only if it is worth more "alive" than "dead.'2 We should use the hedge ratio to compare spreads on options with spreads on stock. If he wants to avoid an exercise notice. Taking all these possibilities into account. and those who want to buy from him probably have positive information. that those who want to sell to him probably have negative information. and uses a maturity date just before the last ex-dividend date. A higher proportion of those the market maker FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 r0 61 dends but the last. and this will cut into the profits he makes trading with those who do not have valuable pieces of information. he should buy in before that date-probably several days before. we get a round trip commission for the option position of around $60. Since an investor can usually get more action for a given investment in options than he can by investing directly in the underlying stock. When the hedge ratio is 0. If the option expires worthless. because the exercise notices will start coming in faster several days before the ex-dividend date. This means that in some cases a market maker or specialist will face a more dangerous trading environment on an options exchange than the specialist on the same stock faces on a stock exchange. the commission is based on the exercise price. For example. we will end up paying much more in commissions than we would in the stock.Facts and fantasy in the use of options-from page 41 try to take the equivalent of a long-term position in the stock by buying or selling options repeatedly. but is no more than $65. When the stock price is well above the exercise price just before the last ex-dividend date." The value of the option alive will be its value with the stock price reduced by the dividend. and has a hedge ratio of 0. And many potential information traders will trade on the options market when they wouldn't bother to trade at all if the options market did not exist. however. To get a position that is equivalent to one round lot of stock in the short run.50 on an option. If we . Also. So many information traders will go to the options market rather than to the stock market. Another element of the transaction cost on either options or stock is the market maker's or specialist's spread: the difference between the highest bid price and the lowest asked price. no furthercommission will be paid. It would not be surprising to find that the market makers' and specialists' spreads are higher on the options market than the spreads for equivalent positions in the stock market.60. For a round lot of stock. we need less than two option contracts. Many of them will have information about the stock that he doesn't have. it will often pay either to exercise or to sell out. This saving. If it ends up in the money. assume that a six-month option with a $40 exercise price sells for $5 when the stock price is $40. Since it takes two option contracts to give the same action as one round lot of stock in the short run. Transaction Costs The transaction costs for trading in options will often be lower than the costs of making an equivalent trade in the underlying stocks. he may find that he has been assigned an exercise notice. He will still lose money trading with those who have important pieces of information. just as we used it to compare commissions. He does know. If it is exercised. we should compare twice the spread in the option market with the spread on the underlying stock on the stock exchange. The value of the option dead will be the stock price minus the exercise price. The holder of an option should be careful to decide whether it will pay to hold it beyond the last ex-dividend date. this comes to $120. and the option will be worth more dead than alive on the ex-dividend date. One reason why a market maker's or specialist's buying price is lower than his selling price is that he doesn't know what information those who trade with him may have. which is about half the commission cost of dealing in the stock directly. with a time to maturity equal to the time between the last ex-dividend date and the date the option expires. it is easier to take a short position by writing options than by shorting the underlying stock. there will be a commission on the closing transaction. (If the hedge ratio were 0. however. because "information trading" may tend to shift from the market for a stock to the market for its options. If he doesn't buy in before the stock goes ex-dividend.50. The round trip public commission for taking a position in the stock is now three per cent or more of the value of the stock.

When the taxable investor writes the option at $6. Options trading will improve the market in the underlying stock. the push to allow institutions to write options freely will be extended so that they will be allowed to buy options. If the option expires worthless. then option values would be lower than the values given by the formula. He can either deliver the stock he holds or buy new stock in the market. Hopefully. To get a rough idea of the amount by which taxes can affect option values. he makes $1. for example. it may be worth $7 to a tax-exempt investor. the effect on option values of assuming a common tax bracket of 50 per cent is similar to the effect of assuming that the stock pays a six per cent dividend. but it is sometimes significant. But an investor in a 50 per cent tax bracket might write three or four option contracts. To get a neutral hedge. If the option goes up. But if the option goes down but ends up in the money. that the hedge ratio is 0. too. The value 62 O FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 will be lower for the investor in a high tax bracket. he will have ordinary income. Even if a piece of information shows up first on the options market. he has an additional possible advantage. We divide the stock price by this discount factor before applying the option formula. A buyer who exercises his option defers realizing a gain or loss. But he will realize his gains or losses from the option. he will realize ordinary income. They both gain at the expense of the government. Investors in low tax brackets also get the benefit of capital gains treatment. If the option goes down. andinvestors in low tax brackets should more often be buyers of options. he will have an ordinary loss. an option will have a different value for an investor in a high tax bracket than for an investor in a low tax bracket. it is unlikely that options trading will reduce the volume of trading in the underlying stock. We multiply this by the fraction of a year that remains before the option expires.0. hedgers will rapidly cause the information to be incorporated in stock prices. Suppose. and they are taxed at lower rates. he can let the option be exercised against him. so long as they are not overpriced. An investor in a high tax bracket who wants a neutral hedge that is long stock and short options will have to write more options than an investor in a low tax bracket. so the government will take half the gain.trades with will have information that can hurt him. he writes four option contracts instead of two against one round lot. So he needs to write twice as many options to get the same after-tax risk he would have if he were tax exempt. the government is taking half the risk. This is true in spite of the fact that investors in high tax brackets who buy options may get the benefit of capital gains taxation of their gains. When tax brackets differ. then he won't realize any gains or losses from the stock. So he may have to set a higher bid-asked spread than the specialist in the stock does (for a corresponding position) just to break even. This means that investors in high tax brackets should more often be writers of options. In particular.13 Taxes It appears that gains and losses for an option buyer will be taxed as capital gains and losses. If everyone were in the same tax bracket. not to the option value directly. The fact that the options market brings out information traders who wouldn't otherwise trade means that the market for the stock will be more efficient than it would be without the options market. If everyone were in a 70 per cent tax bracket. we can calculate a discount factor as follows. If an investor in a high tax bracket writes in-themoney options. we have already noted that a mixture of options and CD's is actually less speculative than an equivalent combination of holding stock and writing options. and thus realize a capital gain or loss instead of ordi- . If the option goes up. But because hedging brings new trading in the stock.50. When the interest rate is 12 per cent. too. and add 1. We multiply the interest rate by the common tax bracket. it means that tax exempt institutions would generally be better off buying options than writing them. he makes $1. he will realize an ordinary loss. The effects of taxes are similar to the effects of dividends on the underlying stock. When the tax-exempt investor buys the option at $6. If he is going to continue to hold the stock. High taxes reduce option values. If the price of an option is $6. so the government will pay for half of the loss. even if it reduces the volume of trading in the underlying stock. A tax exempt investor would buy one round lot of stock and write two option contracts. and $5 to a taxable investor. While buying options is often considered imprudent. In effect. and a writer who has an option exercised against him realizes a capital gain or loss rather than ordinary income or loss. and make it profitable sometimes for an option buyer to exercise his option before it expires. the lower the option values would be. then the higher the common tax bracket. Taxes affect the hedge ratios. while gains and losses for an option writer who buys his options back will be taxed as ordinary income or loss. Note that the discount factor is applied to the stock price. The effect is not huge.

The gains or losses on his stock will remain unrealized. he will have a long-term capital gain of $5. suppose we have an option on a $40 stock with an exercise price of $10. But the option premiums total $8000. This will allow us to illustrate the principles involved in a relatively simple manner. rather than as ordinary income. his brokerage firm will. But there is more. the right to let the option be exercised is not worth much to the writer. his position is perfectly hedged. while the investor has only $4000 in the stock. But he gets no benefit if the stock ends up above $45 or below FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 O 63 . he may be better off letting them be exercised. In effect. depending on his cost basis for the shares. then the writer's ordinary income if he buys the option back is just under $5. Thus both parties to the transaction get an extra three per cent after taxes on their equity. so it will have a value equal to the stock price at all times. and the option sold for $5. And a taxable investor may be able to make money writing it at the same time. Of course. This is the same as the tax-exempt investor's gain. especially if the buyer is an investor in a low tax bracket. This will give him a capital gain or loss. To see how options can be used to save taxes. his net gain is the interest on $1000. Thus his after-tax gains or losses on the options will be only half of his before-tax gains or losses. If the initial price is $40. that the potential tax advantages from the use of options are truly enormous. he may want to let the options on 100 shares be exercised. In effect. Since this interest is taxable. he is getting a $2000 interest-free loan. and if he has held the stock for more than six months. If it is a capital gain. Since he has written options on two shares of stock for each share he owns. depending on the exact amount of the gain. too. the options on 200 shares only offset the gains and losses on 100 shares of stock. he is clearly better off letting the options on 100 shares be exercised. His gain is the interest on $2000. And he gets that without bearing any risk at all. At that price. We will assume a $40 stock. His gain is the interest on $4000 for the life of the option. he gets this benefit only if he gets interest on the proceeds of the options he wrote naked. If he doesn't get the benefit.nary income. on whether it is long term or short term. but it is taxed as long-term capital gains. he gets $6000 for the options. The equity in his hedged position is negative. He can invest that $4000. and pays $8000 for the stock. and on how long he is likely to let the gain go unrealized if he buys the options back. For an option sold with an exercise price equal to the stock price at the time. This should be enough to show. And this doesn't count the substantial extra gain that the taxable investor may get by letting his options be exercised if the stock goes down. In effect. while the gains or losses on the options will become ordinary income or loss. But if he lets the option be exercised. If the stock goes exdividend. His net investment is $2000 for the action on $4000 worth of stock. however. One way to do this is to deal in options that have an exercise price that is not zero. He will gain if the stock ends up close to the initial price (but above it). so he is left with the action on 100 shares. but to buy back the options just before they expire. We will assume that the option can be exercised at any time. The investor doesn't have to buy back all his options at the end. let us consider an extreme example: an option with a zero exercise price. If it is a capital loss. and an option that expires in three months with an exercise price of zero. These factors operate on listed options. Now suppose an investor in a 50 per cent tax bracket owns 100 shares of stock and sells options on 200 shares. and suppose that both writer and buyer agree that all transactions in the option will be at the stock price minus the exercise price. Suppose further that he plans to keep the stock. Since his gains and losses on the options are taxable at 50 per cent. Taking taxes into account. when the interest rate is 12 per cent. These tax benefits can be shared with the buyer of the options. We will assume no dividends. A tax-exempt buyer gets the action on a $40 stock for only $30. They get the return on the stock plus an extra three per cent. Suppose the writer also wants the action on 100 shares. he can accomplish this by buying 200 shares of stock and writing options on 200 shares. His gain is the interest on $10 for each share of stock. For example. the option is a clear bargain for a tax-exempt investor. The profit is the same. and the stock ends up just above $40. Since the options sell initially for $3000 per 100 shares. He is selling options on more shares than he owns. Assuming he will buy back his options at the end. If the price of the stock is lower than it was when the options were sold. his gains or losses on the options will exactly offset his unrealized gains or losses on the stock. They probably explain why options that are well in-the-money (the stock price is well above the exercise price) often sell at tangible value (stock price minus exercise price). the option will be exercised before the ex-dividend day. He has $4000 to work with until the options are exercised or until he buys them back. he gets a $10 interest-free loan. he gets an interest-free loan of $4000 for the life of the option.

Options with less than three months to maturity tend to be overpriced. the investor may want to hold a mixture of options and short-term money market instruments. Those who write short. he can lose all the money he put up. If the stock moves down. they are normally smaller than the amounts he loses interest on if he shorts the stock. But this seems unlikely to give a complete explanation. In general."where the option price is approximately equal to the stock price minus the exercise price. and options that are way into the money tend to be underpriced. But this is often not a problem. we would be able to explain the overpricing of out-of-the-money options. And second. This explanation seems very unlikely for two reasons. a taxable investor who writes naked options realizes ordinary losses if he is wrong. Only tax factors. even if they hold the underlying stock. then he will be earning interest. out-ofthe-money options have speculative positions. the option won't be exercised. Margin Requirements Brokers cannot lend money for the purchase of options. The time spreads that make sense usually involve buying an option with a longer maturity and selling an option with a short64 0 FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 er maturity. This means that the market is not giving the remaining time to maturity any value at all. while capital losses can only be used to offset capital gains plus a small amount of ordinary income. Those who buy short. Another possible explanation for the observed pattern is that market makers and other investors have to be induced to take the indicated positions by the promise of substantial profits. yet they are underpriced. First.000 and sells ten contracts at a higher exercise price for $12. Individual listed options may be priced at times so high that even a tax-exempt investor should write them. If he can keep both the amount he puts up in margin and the premiums he receives in government securities. The ideal strategy might be to use the formula to help taxable investors sell overpriced options and to help tax-exempt investors buy underpriced options. So writing options will be better than shorting stock for both margin reasons and tax reasons. they can lose all the money they put into the options. If it's below $40. They can lose all the money they have invested. Options that are way out of the money tend to be overpriced. The option formula may help in identifying such cases. At least this has been true so far. The stock option hedges that seem most profitable involve buying the stock and selling out-of-the-money options with only a little time left to go. high bracket investors should write options. and low bracket investors should buy them. seem to have any chance of explaining this. They can offer more leverage than the investor can get directly. Ordinary losses can be used without limit. The investor who wants the equivalent of a short position in the stock may be much better off writing options than shorting the stock directly.In that case he won't want to borrow to buy options. he can lose more than all the money he put up. because they are so speculative. and sometimes more. At most. So it may be that those who want conservative positions must pay others to take the speculative positions. it can't explain why in-themoney options are usually underpriced.$40. Perhaps if we assumed a more complicated pattern for changes in a stock's volatility. it can't explain why competition among writers doesn't eliminate the overpricing of out-of-themoney options. the pattern may change. because to get the equivalent of buying a stock on margin. out-of-the-money options and mix them with CD's have conservative positions. and would be glad to earn extra money by writing overpriced options if writing options were not so . Thus the money spreads that make sense usually involve buying an option with a lower exercise price and selling a corresponding option with a higher exercise price. The underpricingof way in-the-money options is so extreme that they often sell at "parity. One possible explanation for this pattern is that we have left someting out of the formula. A sudden large move in the stock price in either direction may give him great losses. or for changes in interest rates. Even if he loses interest on one or both of these amounts. A market maker who buys one option contract for $1. But even an option sold with an exercise price equal to the stock price at the time has a tax value to a writer in a high tax bracket. while an investor who shorts the stock realizes short-term capital losses if he is wrong. Further. Still another possible explanation is that options give a form of leverage that is otherwise unavailable because of margin restrictions. As time goes on.50 each is taking a great risk. Actual Prices The actual prices on listed options tend to differ in certain systematic ways from the values given by the formula. There are great numbers of investors who have as much leverage as they want. and that investors bid up their prices because of the leverage they get. as discussed above. If the stock moves up. or so low that even a taxable investor should buy them.

And in fact.+ (r d2 1v2) (t*-t) 2 In this formula. An increase in the interest rate will always increase the value of the option. They are just arranged differently. a change of a few days or a week usually has only a modest effect on the option value. Further. Or it is the number of round lots of stock needed to balance one optioncontract to create a hedged position.speculative. 65 . the Commission has imposed restrictions on the trading of options that are way out of the money. and short positions are as easy to open as long positions. v2 is the variance rate of the return on the stock (a measure of the stock's volatility). Note that even a five percentage point change in the interest rate usually has only a modest effect on the option value. c is the exercise price. and w(x. The greatest effect of the interest rate occurs in the longest maturity options. Reading across. It is hard to see how this can be in the public interest. we see how the value changes as the volatility increases. So this seems like a situation where any possible problems can be adequately solved through additional disclosure. t is the current time. The other symbols in this formula are defined as they are for the option formula. An increase in either the stock price or the maturity will always increase the value of the option. Regulation The SEC seems to be doing a good job in regulating options trading. t* is the time at which the option expires. Table 2 makes it easy to see the influence of stock price and the interest rate. FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 O cer(tt)N(d2) v2v) (t*2t) + (r + dl c= =ln. t) = xN(dl) I=n- The "hedge ratio" is given by Equation 14 on page 645 of the article by Black and Scholes (1973): w1(x. If the SEC restrictstrading. An increase in the volatility will always increase the value of the option. It has allowed the creation of exchanges that are more advanced in several respects than existing stock exchanges. TABLES OF OPTION VALUES AND HEDGE RATIOS The tables given below show the values and hedge ratios for an option with an exercise price of $40. t) is the value of the option at time t when the stock price is x. we see how the value of an option changes as the stock price increases. Clearing facilities are more modern and lower in cost. Note that while a change of several months in maturity has a substantial effect on the value of an option. In is the natural logarithm. Reading across. THE FORMULA The simple option formula is Equation 13 on page 644 of the article by Black and Scholes (1973): w (x. we see how the value changes as the maturity increases. t) = N(d1) In this formula. N(d) is the cumulative normal density function. However. t) is the derivative of the option formula with respect to the stock price. . There are six different stock prices. the formula suggests that such options are usually overpriced. an increase in the volatility of the stock causes a very large percentage increase in the value of the option. I think we have to say that we don't know why some kinds of options are consistently overpriced according to the formula and others are consistently underpriced. no one has to buy these options. r is the interest rate. for different values of the other inputs to the option formula. Apparently the Commission feels that those who buy way out-of-the-money options are throwing their money away. It is the change in the option value for a small change in the stock price. wl(x. APPENDIX B. three maturities. The figures in Table 2 and 3 are the same as the figures in Table 1. and nine values of the volatility (annual standarddeviation). The hedge ratios are in parentheses. Table 3 makes it easy to see the influence of stock price and the volatility of the stock. Table 1 makes it easy to see the influence of stock price and maturity. it will hurt those who buy options to reduce their exposure to loss as well as those who buy options to increase their potential gains. At the moment. x is the stock price. Reading down. because there is so little chance that they will be worth anything at maturity. we see how the value changes as the interest rate increases. three interest rates. But we have already noted that careful buyers of such options are actually bearing less risk of catastrophic loss than those who write the options. Note that when the stock price is well below the exercise price. Reading across. divided by the change in the stock price. a APPENDIX A. Anyone who wants to can write them instead.

18 (0.39 (0.60 (0.40 9.57 2.63) (0.06 (0.35) (0.27 0.85) 13.09 9.71) (0. 32.98 14.44) (0.63 4.74) (0.80 (0.36) 1.05 2.92 (0.87) (0.96 (1.90) 9.04 0. 48.99 3.95 6. 48.97 12.90) InterestRate= 0.82) InterestRate= 0.05 3 Months 6 Months 9 Months 0.60) (0.04 1.65 7.20) (0.89 5.00) (0.08 11.11) (0.59 (0.15 3 Months 6 Months 9 Months 0.54 9.36) 1.42 (0.94 (0.58 4.00) (0.80 16.11) (0.73) (0.37 0.35) (0.92 5.20) (0. 40.18 0.11 (0.94 (0.32 1.13 0.94) (0.18 9.81) (0.TABLE Option Values and Hedge Ratios for Different Stock Prices and Maturities.56 17.59) 4.14 (0.42) (0.22 8.40) 1.23 0.53 2.21) 0.30 (1.79 9.54 (0. 32.68) (0.93) (0.45) 2.06 12.99) (0.36 (0.22 0.90) Annual Dev= 0.97 8.13 (0.04) 0.12) (0. .01) (0.87) 13.03) (0.29) (0.45) 2.89 2.86) (0.68 11.82 (0.97) (0.86 1.50 13.72 3.87) InterestRate= 0. 36.81) (0.71 4.82) (0.73) 10.02 10.32 (0.11 16.78) (0.97) (0.94) (0.95) (0.83) (0.92 1. 40. 32. 52.20 Std Exercise Price= 40.02) (0.15 3 Months 6 Months 9 Months 0.15 0. Price 28.70) 5.00) (0.16) (0.58) 3.92) InterestRate= 0.66) (0.17) 0.63 (0.55 1.56) 3.37 2.85 2.19 1.82 (0.55 7.84) (0.24) (0.79) (0.78) 10.60 13.98) (0.05 3 Months 6 Months 9 Months 0.61) 6.49 (0.32) (0.82) 13.96 (0.33) 1.49) (0.38) 3.91 16.16) 0.38) (0.34 12.12 3.51) (0.61) (0.50 0.96) (0.74) (0.27 1.72 (0.64 (0.28) 0.19) (0.93) (0.78) 9.58 (0.89) (0.17) (0.26) (0.41) (0.24) (0.55 2.57) (0.49) 3.50 (0.62) (0.59 13.85) (0.48) 2.82 (0.74) (0.59) (0.79) (0.07 (0.20 (0.83 (0.38 4. 44.52) 4.59) (0.44) 1.96) 13.10 3 Months 6 Months 9 Months 0.80) 9.62) 5.07 (0.59) (0.91) (0.51) 2.07) (0.15) (0. 40.87 (0.46) 2.96 (0.33) 1.88 (0.99) (0.72 (0.39) (0.04 7.41 7.82) (0.12 (0.27 (0.60 (1.08 1.74) (0.98) (0.07) (0.92) (0.56) 4.60) (0.62 2.27) (0.06 13.51 1.46 3.71) 9.59 12.22) (0.99) (0.11) (0.11 (0.16 2.89) (0.23) (0.99) InterestRate= 0.04 13.31 (0.66 11.75) (0.12 (0. 32.97) Annual Dev 0.12) (0.78 8.92) (0.09) (0.38 12. InterestRate= 0.02 0.24 (0. 36.84 16.67 (0.37) (0.48) (0.29 14.45 1.10 3 Months 6 Months 9 Months 0.41 (0. Annual Dev= 0.70 (0.84) InterestRate= 0.22 (0.54) (0.40 Std Exercise Price= 40.79) 13. InterestRate= 0.23 0.10 16. 52.23 0.75) 9.28 (0.37 14.89) (0.05 3 Months 6 Months 9 Months 0.76) (0.40) (0.59) (0.00 0.49 (0.91 14.26 3.00) (0.23) 1.44) (0.54 (0.93 (0.85 11.15 3 Months 6 Months 9 Months 0.38) (0.91) (0.74) 8.63) (0.76 (0.44 6.53) 3.36 5.02 (0.71 (0.61) (0.09) (0.41 3.94) (0.68) 7.65) 6.65) 7.26) 0.59 6.83 (0.43 6.92 5.44 (0.22 4.49 10.25 (0.18 (0.22) 0. 44.09 (0.84) (0.96) (0.82) 9.29 0.71) 6.73 (0.01 0.06) (0.51 8.27 14.62 (0.58 5.94 1.73) (0.85) Annual Dev= 0.12) (0.00) (0.98) (0.03) (0.98) (0. Price 28.25) (0.31) (0.16 4.18 (0.72) (0.82 (0.40 (0.15 3 Months 6 Months 9 Months 0.80 10.38) 1. 44.38 8.60 1.24 15.98) (0.62) 6. 48.49 (0.42 4.88) (0.78 10.41 4.29 18.82) 14.19 2.42) 2.67 1.23 10.44) (0.61 (0.83) (0.62) (0.01 (0.85 14. Price 28.66) (0.85 (0.09) 0. 36.35 (0.21 8.05) (0.09) (0.45 0.00 0.89) (0. 52.89 4.93 7. 40.63 11.59 (0.02) (0.66) (0.01) (0.26 (0.30 Std Price= 40.30) 0.02 0.93) (0.02) (0.87) (0.87 3.26 0.47 14.51) (0.56 3.77) 13.49 (0.00) (0.73 15.57) (0.84 3. by Standard Deviation 1.17) (0.36) (0.00 0.77) (0.31 4. 44.67 5.70) (0.35) (0.20) (0.02 0.42 0.84) 12.20 (0.76 1.23 5.86) Price 28.86) (0.56) (0.02) (0.76) 10.06) 0.87) (0.48) (0.22 6.19) (0.59 17.22 12.90) 13.36 6.77) 5.82) (0.05 3 Months 6 Months 9 Months 0.04 0.65) (0.21 (0.10 3 Months 6 Months 9 Months 1. and Interest Rate.77 11.21 10.11 7.29) (0.66) 5.29) 0.86) (0.94) (0.22 2.40) (0.94) 12.56) (0. 48. 36.76 (0.30) 2.83 8.15 (0.80) (0.65 1.23 (0.65 10. InterestRate= 0.07 2.06 14.86) (0.70 (0.65 (0.86) 9.32) (0.44) (0.14) 0.28) (0.10 3 Months 6 Months 9 Months 0.98) InterestRate= 0.11) (0.21 6. 52.04) (0.79) 12.30 (0.73 7.05 7.25 13.87 (0.01 15.99 13.61) 5.03 0.12 0.91) 12.94) InterestRate= 0.90) (0.70) 9.02 0.91 9.78) (0.50 Std Exercise Price= 40.62) (0.56 (0.26 10.88 3.58 11.85 3.60) (0. Exercise InterestRate= 0.03 0.90) (0.24) (0.27) (0.83) (0.82) (0.55) 2.91) (0.72 8.88) (0.69) 6.55 1.69 6.39 1.21 3.68 15.35 2.71) (0.57 8.90 6.63 6.17 (0.84 (0.53 15.

33 4. Exercise Annual Dev= 0.26 (0.83 (0.60 InterestRate= 0. 36.28 14.49) (0.78) (0.15 (0.59) 14. 44.47 11.13 10.04 15. 32.46) (0.33 (0.74) (0.67) (0.66) (0.15 9 Months 3 Months 6 Months 5.49) (0.05 (0.33 8.65) (0.81) (0.22 7.74 (0. 48.01 5.05 9 Months 6 Months 3 Months 2.13 2.24 10.60) (0.99 (0.39) (0.35 2.64 1.29 5.49 (0.11 17.95 (0.15 6 Months 9 Months 3 Months 3.98 (0.56) (0.57) (0. 48.56 7.36) (0.11 (0.84) (0.53) 13.30) 3.60 4.59) (0.49) 11.80) InterestRate= 0.45) (0.43) (0.22 (0.92 10.79 13.40) (0.85 20.95 15.67 (0.21 11.03 16.60) (0.39 (0.67 1.72 11.70) 18.86 (0.20 (0. Price 28. 40.52) (0.60 (0.05 9 Months 6 Months 3 Months 5.76 1.48) (0.21) 5.75) 22.71 3.23) 4.51) (0. 44.35 4.54 8.73) (0.92 4.62 19.31 1.14 7. Std Annual Dev= 0.78) (0.82) (0.39 9.53) (0.99 (0.92 6.10 9 Months 6 Months 3 Months 3.75) (0.87 11.61) 16.64) (0.76) 18.36) (0.75) (0.64) (0.16 6. Price 28.70) 19.81 7.93 4.52) (0.66) (0.62) (0.42) (0.42) (0.80) (0.30 (0.90 Std InterestRate = 0.84 8.79 10. 32.79) (0.62) 16.70 InterestRate= 0.09 1.99 (0.10 3.37) (0.61) 14.19 10.54 (0.74) 21.85 7.83 (0.77 (0. 40.55 (0.18) 5.69) 19.19 7.72) (0.44 8.23 10.56) (0.63 (0.41 6.88 6.69) 17. Price= 40.44 4.77) 18.95 6.44) 5.83) (0.05 9 Months 6 Months 3 Months 2.34) (0.13 19.50) (0. 52.78) (0.74) (0.67 6.44) (0.79) 17.80) 16.58 (0. 52.96 (0.76) (0.50) 9.67) (0.50) (0.62 13.69) (0.78) 19.51 (0. (Continued) Price 28.42 2.83) Exercise Price= 40.40 (0.87) InterestRate= 0.78) (0.27 1.76) (0.55) (0.41 18.73 12.07 5.63) (0.70) (0.75) (0.80) (0.48 3.57 3.56) (0.58) (0.02 14.27) 7.75 12.88 14.71) (0.83 (0.89 (0.72) (0.71) 17. 36.35 15.61) (0.07 6.51) 12.60) 13.76) 22.82) (0.35) (0.81) (0.76) (0.60) 14.89 13.93 8.02 10.1.79) (0.74) (0.86 (0.86) Price= 40.80) (0.70 8.69) (0.27 (0.12 5.52) 13.53 6.75) (0.68) (0.28) (0.64) (0.79) 20.58 (0.51) (0.55 (0.72) (0.45 14.60 4.76) (0.62 4.59) 10.46) 8.77 (0.70) (0. Exercise Std Annual Dev= 0.60 3.32 2.61 3.29) 6.11 5. Exercise Std Annual Dev= 0.73 11.49 6.64 10.91 12.33 (0.57) (0.69) 14.74 11.25 6.33) (0.37) 8.75) 20.71) 15.70 11.81) 17.41) (0.80) (0.67) (0.76 16.77) (0.78) (0.03 9.87 15.36 7.54 (0.42 3.16 4.05 2.38) (0.89 (0.05 9 Months 6 Months 3 Months 3.78) (0.55 (0.23 2.62) (0.27 11.79 (0.44 (0.51 3.10 6.46) (0.42 (0.69) 15.79) (0.16) 4.67 (0.66) (0.64) (0.64) (0.30 6.14 (0.81) (0.81) (0.81 (0.84 11.25) 6.15 9 Months 3 Months 6 Months 4.97 2.76) (0.91 4.52 (0.75) (0.45) (0.70) 16. 36.55) (0.82) (0.33 2.39 9.44 20.64 6.30) 8.67 3.43 5.92 1.69) (0.43) 11.53) (0.84) InterestRate= 0.80 (0.26 3.55) (0.40 13.59) (0.95 1.80) (0.28 (0.35) (0.26 12.71) (0.30 9.61 (0.20 (0.59 15.58) (0.24 4.45 18.10 9 Months 6 Months 3 Months 3.71) (0.53) (0. .79) (0.63) (0. 52.02 15. 36.60) (0.78 (0.72 5.01 (0.05 0.66) (0.05 0.72 (0. by Standard Deviation and Interest Rate. 32.79) (0.49 16.62) (0.85 15.16 8.73) (0.81) Price 28.15 9 Months 6 Months 3 Months 6.46 7.61) 12.38) 9.53) (0.42) (0.93 5.41) 10.28 15.02 13.47) (0.97 (0.44 12.19 (0.77 3.85 (0.69) (0.57) (0.50) (0.99 (0.66) (0.80) (0.43 18.77) 21.81) (0. 44.32 (0.68) (0.49) (0.58) (0.10 9 Months 6 Months 3 Months 5.40) (0.01 5. TABLE Option Values and Hedge Ratios for Different Stock Prices and Maturities.85) InterestRate= 0.72) 16. 44.59 (0.55) (0.03 (0.70) (0.91 5.42 14.61) (0.40 9.12 1.81) Price= 40.78) (0.58 (0.48) 10.10 6 Months 9 Months 3 Months 1.26) 7.25 5.84 (0.11 11.81 1.75 7.62 (0.91 2.12 19.00 (0.58) (0.08 7.22) 5.52 10.75) (0.52) (0.77) (0. 40.64) (0.10 (0.32) 7.58) 9.72) (0.39 (0.75 (0.45 (0.83 (0.74) (0.79 (0.31) 8.77) (0.72) (0.33) (0.66 10.48 (0.71) (0.51) (0. 48.87 2.41 3.30) (0.47) 8.14 4.69) (0.68) 18.69) (0.60) 15.23 (0.37 12.19 13.81 11.69 0.16 (0.81 14.38 14.72 0.40) 9.69 13.74) (0.45 (0.47 10.59 17.47 15.83) InterestRate= 0.62) (0.75) (0.32 (0.82) InterestRate= 0.77) (0.12 2.84) (0.44) 8.50 3.80 (0.67 16.30 (0.88 (0.72) (0.17) 3.62) 12.22 1.58) 12. 48.03 (0.79) (0.29) 7.68) 17.63) (0.61) (0.36 (0.01 16.42 13.40) 10.80) (0. 40.49) 11.87) InterestRate= 0.81) InterestRate= 0.80 InterestRate= 0.71) (0.45) (0.46) 8.41) (0.65) (0.02 13.70) (0.73 (0.45) 9.51) 12.94 9.08 15. 32.08 (0. 52.59 (0.53) (0.48) 8.69) (0.36 4.

41 (0. Price 28.94 (0.23 (0.11) (0.84) (0.15 0.96 (0.41 (0.57) (0.39) (0.19) (0.65 (0.01 (0.87) (0. 48.49 (0.46 (0.76 (0.06) 0.92 1.29) 2.92 (0.07) 2.71) (0.73) 11.08 (0.41) 6.59 13.24) 2.58 (0.84) R=0. 36.10 0.32) 3.29 13.85) Annual Dev= 0.65) 8.79) 10.26 (0.01) (0.95 (0.42) 6.53 0.91 (0.57) (0.89) 6 Months R=0. 3 Months R=0.00) 9 Months R=0.86) R=0.51) 4. 36.72) 12.15 0.29 (0.03 0.23 (0. 3 Months R=0.59 (0.30 Std Exercise Price= 40.49 (0.86) 10.98) R=0. 40.05 0.56) (0.05 1.61) 6.73 (0. Deviation and Maturity.15 (0.44) 5.97) Annual Dev= 0.58 (0.38 6.87) 15.44) (0.49) 5.50 (0.79) 16.15 0.01 (0.67 (0.27) 3.94) 6 Months R=0.15 0.90) Annual Dev= 0.84) 12.12 0.05 (0.38 (0.00) 0.61 (0.77) 12.11) 1.68) 8.94) Price 28.20 Std Exercise Price= 40.76) 14.13 (0.99) 13.87 (0.82 (0.83) 14.22 (0. 48.02 0.42 3.55) 5.57 (0.09) (0.17) 1.60 (0.48) 5.02 (0.70) 7.78) 13.82) 11.89 (0.27) 5.51 (0.44 (0.51) 6.92 (0.22 (0.37 (0.22) 1.23 9.32) 3.03 (0.15 1.78) 11.93) 13.21) 1.26) 1.41 2.96) 13.74) 13.87 (0.03) 0.65 (0.70 (0.71 (0.61) 5.16) 2.24) 2.83 (0.88) 15.38 (0.37) 3.43 (0.05 0.62) 9.23) 2.67 3.98) (0.82) R=0.44) 4.05 0.80 5.09 7.10 R=0.11) 2.75) (0. 48.46) 3.98) R=0.28 (0.12 1.72 (0.25) 3.31) (0.83) 10.42) 2. 32.82) (0.91) 15.79) (0.11 (0.69 (0.91 (0.05 1.36) (0.07 (0.49) 3.56) (0. 40.15 0.22 5.75) 12.91) 9 Months R=0.18 (0.00) (0.16) 0.71) 9.40) 3. 36.55 (0.99 1.38) 3.89) 14.94 (0.10 0.82 (0. R=0.24 (0.85) 17.06 (0.62 (0.74) 11.10 R=0.11 (0.34 (0.94) R=0.33) 2.95) R=0.80) 15.45 0.84) 16.02 9.06) 1.99) Price 28.98 (0.36) 1.88) (0.63 (0.74) 13.38) 4.60) (0.90 (0.65 (0.29) (0.62) 4.68) 11.19 0.28) 0.05 1.25 (0.61) 8.86) 10.31 (0.00) 6 Months R=0.10 (0.56) 6.26 (0.31 (0.86) (0.81) (0.92 (0. 44.18 (0.73) 7.00) 0.56 (0.36 5.74) 8.58 (0.82) (0.02 0.76 (0.79) 12.21 (0.58 (0.17) (0.55 (0.47 (1.65) 10.20) 3.60 (0.90) Price 28.12) 1.66) 9.08 (0.89) (0.45 (0.45) 2.27 13.21 (0.27 (0.59) 7.14 (0.59) 8.85 13.00 0.60) 6.20) 2.48) (0.22 (0.62) 8.68 (0.09) 0.37 (0.00 0.94 (0.50 12.66) 7.03) 0.70) 9.05 R=0.36 0. R=0.74) (0.22 10. 44.44) 7.99 13.98) 13:04 (1.82 (0.04) 0.84 (0.66 10.04 (0.50 Std Exercise Price= 40.56 (0.35) 4.26) 3.26 9.53) 5.69) 10.05) (0.15 0.35) 4.54 9.09) 0.82) 12.63 2. 3 Months R=0.61) 10.TABLE Option Values and Hedge Ratios for Different Stock Prices and Interest Rates.88 (0.02) 1.84 (0.77 (0.04) 1.52) 4.73 6.32 (0.05 1.60) (0.59) (0.59) 8.62 (0.86) .49 (0.04 (0.76) 10.32 0.98) R=0.91 (0.11) 1.59 (0.59 (0.40) 5.15 0.71) (0.23) 0.54 (0.63 (0.94) 14.90) 11.82) 18.85 10.98) (0.20) (0.78) 11.17) 1.89 (0.25 (0.63 (0.30) 0. 3 Months R=0.94) (0. 36.02 (0.78 (0.36) 4.10 R=0.30 (0.70) (0.86 (0.91) R=0. 32.24 (0.12 (0.78 7.36 (0.77) 8.23 0.66) 6. 52.93 (0.92) 9.49 (0.22) (0. by Standard 2.06 (0.29 (0.94) 14.48) 6.35 0.12 (0.56 (0.59) (0.02) 0.18 (0.20 (0.96) 9 Months R=0.91) 12.96 (0. 48.07 (0.05 R=0.40 (0.68 14.65 (0.05 0.05 R=0.58) 7.82 (0.82) 15.30 (0.04 6.15 0.76 (0.15 2.23 (0.19) 2.89) 9.27 (0.53 (0.60 (1.10 1.87 (0.62) 5.83 (0.64 (0.70 (0.87) 14.30) 3.93) (0. 52.00) (0.16 (0.13 0.02 0.85) 16. 40.18 (0.10 2.93 (0.99) 9 Months R=0.37 (0. R=0.12) 2.09) (0. 52.99) 6 Months R=0.18 (0.40) (0.00 (0.59 (0.15 1.40 (0.81) 9.11 (0.42 (0.06 (0.97) (0.42 (0.40 Std Exercise Price= 40.85 2.15 0.35 (0.05 R=0.15) (0. 44.82) 17.73 (0.78) (0.88 (0.56) 6.01 (0.17 (0.02) (0.10 0.93) (0.60 0.01) (0.80 (0.77) 13.63) 7.07) (0.66) 6.97 (0.44) 4.92) (0.57 1. 44.23 (0.26 2.10 0.96 (0.38) 4.11 (0. 32.04 (0.02) 0.89 3.51) 6.28) 3.05 0.85 (0.49 (0.83 (0.22 (0.16 (0.45) 4.35) (0.79 9.09 (0.73) 12.90) 12.90) R=0.96) 16.72 1.85 (0.84 (0.10 0.33) 2.83) 14.55 (0.59 (0.71 (0.86) (0.97 (0.92) R=0.38) 2.87) R=0.72 (0. 40.97) 14.39 (0.39 (0.06 13.22 (0.55 (0.19 (0.90) 16.87) R=0. 52.21 (0.71) 9.63) 7.15 (0. 32.07 1.62) 6. Annual Dev= 0.21 (0.29) (0.12) 3.14) 0.50 (0.51 (0.54 (0.65) 9.54) 8.67 (0.21 4.41 (0.27 (0.10 R=0.80) 8.72 (0.10 1.20 (0.44 4.80 (0.24) (0.

45) 7.32 12.15 R=0.74) (0.44 (0.74) 19.84) R=0.71) 14.46) 6.91 2.69) 15.33) 4.39 (0. 32.24 (0.84) 9 Months R=0.80) R=0.80) R=0.78) (0. 40.76) 17.79) R=0.69) 11.21) 2.44 5.32) 6.30) 5.66) 10.14 9.41 (0.76) 19.49) 7.55) (0.60 (0.05 (0.66) 13.74) (0.88 (0.89 (0.77) 20. 48.15 2.79) 18.61) 13.05 3.22 4.81 (0.87) 9 Months R=0.67 (0.52) 10.12 1.66) 14.92 (0.75) 19.88 (0.70) (0.75 7.19 (0.98 (0.03 (0.60 (0.83 (0.70 Exercise Price= 40.16) 1.93 (0.78) (0.57 1.45 5.52 (0.53 3.73) 15.62 (0.41) 7.61) (0.31 (0.58) 8.61) 13.72) 17.80) 19.80) 6 Months R=0.48 (0.80) R=0. 32.14 (0. Exercise Annual Dev= 0.08 (0.49) 5.99 (0.87 (0. Exercise Price 40.60) (0.67) 16.15 3.62 (0.07 (0.50 (0.82) Price 28.72) 14.69) 15. Price= 40.46) 6.26 (0.50) 9.05 1.42) 5.68) 12.62) 11.42) (0.35) 5.14 (0.69) (0.79 (0.60) 9.38) (0.83) 6 Months R=0.10 (0.64) 11.92 (0.53) 6.55) 7.58) (0.25 (0.79) 18. 40.79) (0.86 10.05 0.99 (0.49) 6.85 (0.77 (0. Exercise Annual Dev= 0.77 (0.62) (0.75) (0.61) 12.15 5.66 (0.34) 2.70 (0.93 (0.72 (0.58) 8.89 (0.95 (0.42) 5.55 (0.36 9.42 (0.52) 8. 40.71) 15.74) 16. 48.94 (0.33 (0.71) 13.08 (0.21 (0.01 (0.64 (0. 48.29) 3.56) (0.47) (0. 52.87 8.48) 5.47) 8.60) 11.69) (0.33 (0. 52.70) 16.95 (0.27 5.81 (0.74) 17.78) 22.02 (0.53) 12.55) 8.99 (0.40 (0.22 (0.0.20 13.11 (0.58) 8.64) 12.78) 19. 36.35 (0.15 4.59 (0.80 (0.10 R=0.05 5.71) (0.10 (0.63) (0.53) 8.76) 17.77) 20.65) 13.15 R=0.60) 10.61) 10.59) 10. R=0.17) 3.78) 16.68) 13.83 7.57) 9.97 1.25 (0.71) 16.09 (0.82) 9 Months R=0.74) 18.79 (0.91 (0.78) (0.40) 8.77) 18.55 (0. 36.39 (0.42 (0.45) 6.60 Std 3 Months R=0.16 (0.65) 12.12 (0.80 15.72) 16.40 (0.81) R=0.95 (0.10 (0.51) 6.22 6.70) 18.91 (0.60) 10. 52. 32.67 (0.05 2.12 (0.45) 8.47 (0.33 (0.44 (0.15 15.43 (0.76 (0.49 (0.05 0.54 7.01 (0.76) (0.88 11.00 (0.28 (0.52) 7.89 (0.13 7.37) 4.68) 12.42 (0.54 (0.85) R=0.58) (0.59 (0.84 (0.43 (0.53) 10.61 1.29 2.39) 3.51) 7.28) (0.62) 14.87 (0.67 (0.61 (0.10 2.15 4.05 3.73) 16.35 (0.80) R=0.83 (0.58) 8.39 (0.44) 5.73 (0.81 (0.10 1.23) 5.10 3.41 3.64) 12.72) 19.70) 17.92 (0.25) 2. 36.82) R=0.77) 22.75) 15.10 4.81) R=0.67) 11. 44.55 (0.96 3.83) R=0.02 (0.72) 15.28 11.74 (0.75) (0. 44.10 1. Annual Dev.62 (0.28 (0.79) 20.56 4.70) 13.10 4.80 Std 3 Months R=0.51) 11.19 (0.87) 6 Months R=0.86) Annual Dev Std Price 28.11 (0.59 12.32 (0.63) 10.73 (0.92 (0.82) R=0.76) 18.77) 14.50) (0.76) 21.23 (0.67) (0.71 1.30 (0.15 2.63) (0.72 (0.40) 5.51) (0.47 (0.79 (0.46 (0.03 (0.36 (0.79) 14.90 Std 3 Months R=0.03 (0.19 (0.79) R=0.75 (0.30 (0.16 (0.91 (0.83 (0.TABLE Option Values and Hedge Ratios for Different Stock Prices and Interest Rates.75) (0. (Continued) Price 28.31) 7.02 (0.53) (0.79 2.80) 15.59) 9.01 3.30 2.61) 11.15 R=0.43) 10.41 (0.69) (0. 40.67 0.66) (0.81 (0.02 (0.50) (0.38 (0.40) 5.57) 10.51 (0.44 (0.10 3.49 1.40) (0.51 (0. 48.53) 7.74 (0. 44.62 (0.76 (0.67 (0.36) 7.10 R=0.85 (0.33 (0.35) 4.23 (0.62) 8.27 (0.85 (0.35 (0.80) (0.46) 5.83) 0.56) 9.81 (0.20 10.55) 8.05 3.64 (0.42 (0.05 4.10 5.27) 6.47 (0.69) 11.81) 17.15 R=0.64 (0.05 (0.49 (0.37 (0.51) 9.58 (0. 36.75 (0.52) 6.64) 11.01 (0.36) (0.69 (0.72) 13.05 2.75) 15.13 (0.58 (0.49) (0.81) 9 Months R=0.84 (0.72) 14.76) 20.26 (0.30 (0.07 (0.15 3.41) (0.68) 12.46) (0.63 9.08 (0.48 16.62) 10.42 (0.64) (0.26) 4.10 R=0.43) 6.81) Price= 40. 32.81) Price 28.39 10.69) 14.52 (0.59) 11.05 (0.78) 16.04 (0.75) 16.84) R=0.36 (0. by Standard 2.77) 17.72 (0.71) 12.37) 5.58 14.69) 13.81) (0.10 3.29) 3.72 0.13 (0.81) .49) 10.78) 21.79) (0.60 (0.84 (0.38) 6.78 (0.75) 18. 3 Months R=0.44) 4.02 (0.30) 4.77 6.93 (0.33 (0.50) 7.56) (0.22) 3.11 (0.16 14.44) 4.54 (0.69) 14.69 (0.60) 11.66) 13.26 (0.33) 3.32 (0.80) R1=0.73 4.86 (0.18) 4.62) 15.05 2.30) 3.19 (0.59 (0.11 (0.03 13. R=0.27 (0.45 (0.48) 8.99 6.60 (0.23 (0.41) 7. 44.64) (0.59) 9.67 (0.45 15. 52.45 (0.12 (0.70 (0.81) 6 Months R=0.95 (0.97 (0.75) (0.24 (0.15 6.16 (0.40 (0.44 (0.69) 11.57) 9.48) 8.71) 15.70) (0. Deviation and Maturity.70) (0.85 (0.05 1.45) (0.05 1.

56) 5.53) S.32 (0.54 (0.62) 9.77 (0.71) 9.98) (0.33) 3.D.26) 2.78) 14.20) 1. 44. S.67 (0.12) 1.11) 1.56 (0.17) 1.64 (0.81) S.28) 3.=0.29 (0.=0.78 (0.49 (0.70) 11.65 (0.81) (0.94) Price 28.12) 1.70) 13.10 Exercise Price= 40.74 (0. (0.50 0.27) 2.74) 10.75) 9.08 (0.48 (0.03) 0.D.10 (0.67 (0. 48.70 1.05 (0.23 (0.43) 5.18) 1.84 (0.20 0.20 (0.83) 9.63) 11. 44.13 (0.12 (0.76) 15.79) 15.D.87 (0. 32.91 (0.12 (0.87) 8.89) S.35) 3.D.88 (0.18 (0.32 (0.36 (0.88 (0.76) 9.01) 0.26) 2.22 (0.60 1.55 (0.59 (0.60 (0.40) 4. 0.13 (0.63) 6.92 (0.53) 7.60 (0.63 (0.27 (0.04 (0.67 (0.02) 0.72 (0.=0. 6 Months R = 0.59 (0.03 (0. 48.09 (0.79 (0.61) 7.00) 0.D.18 (0.=0.74) 17.=0.92 (0.20 0.74) 9.59) 9.99 (0.=0.56) 6.D.83) S.58 (0.66) 5.69.19 (0.38) 3.99) 13.92) 12.D.=0.47 (1.=0.90 3.85 (0.04 (0.23 (0.68 (0.30) 3.30 0.83 (0.85 (0.42 (0.D.70) 12.75) 15.00 (0.56) S.55 (0.81) S.35 (0.72 (0.36) 3.27 (0.59) 7.80 1.30 (0.57 (0.50 0.79) 13.=0.19 (0.33 (0.58 (0.03 (0.44) 4.35) 3.92) 9.=0.D. Option Values and Hedge Ratios for Different Stock Prices and Standard Deviations.27) 2.63 3.05 Exercise Price= 40.00) 3 Months R S.83 (0.=0.59) 7.73 (0.69) 12.70 0.22) 2.42) 4.44 (0.91 (0.99 (0.71) 11.71) 10.69) 12.03 48.87) S.62) 10.16) 1.80) S.21) 2.05 (0.61) 8.38) 4.60) 9.29) 2.06 (0.51 (0.45 (0.11 (0.D.78) 14.95) Price 28.=0.15 Price= 40.87 (0.11) 0.99 (1.71 (0.81) 14.=0. Exercise S.22 (0. 52.D.98) 12.90 1.85 (0.=0.84) (0.86 (0.59) 6.41 (0.80 (0.92 (0.62) 10.00) 0.=0.59) 7.34) 3. 40.80) (0.22) 2.02 (0.36 (0.49) 6.15) 1.46) 5.=0.38 (0.37) 4.02 (0.60 0.69) 15.98 (0.83) S.95 (0.=0.54 (0.30 0.40 S.21 (0.55 (0. 52.72 (0.41 (0.86 (0.26 (0.40) 4.45 (0.01 (0.75) 16.59 (0.91) S.79) (0.=0.04 (0.=0.=0.49 (0.01 (0.90 2.03 (0.63 (0.05 (0.97) 0.16 (0.05 (0.37 (0.38) 4.60) 8.23 (0.61) 9.73 (0.30 0.89 (0.09) 0.D.52) 7.30) 3.70) 11.17) 1.=0.80) 14.57) 6.86) 12.74) 15.53 (0. 40.55 4. 32.69) 13.51) 6.35) 3.87) S.25) 2.67 (0.41) 5. 2.76 (0.85) S.76) 15.16 (0.25) 2.00) 3 Months R S.51) 7. 44.84) 14.58) Price 28.80 3.94 10. 40.30 S.39 (0.76) 16.47) 6.00 (0.70 (0.29) 2.D.84) S.93 (0.31) 3.93) S.53 (0.93) 13. 52.74) 18.16 (0.68 (0.89 (0.01) 0.42 (0.26 (0.D.60) 5.57) 4.89 (0.07) 0.20 0.07) 0.00) 0.52 (0.08 (0.95 (0.D.12 (0.32) 3.79) 8.89) 9.48) 6.79 (0.11) 1.02 (0.60) 9.78) 1975 JOURNAL JULY-AUGUST / 70 O FINANCIAL ANALYSTS .88) (0.62) 5.65 7.D.D.39 (0. by Maturity and Interest Rate.69) 10.61 (0.05) 0.44) 4.01 (0.29) 3. Exercise S.TABLE3.D.61) 10.87 (0.D.40) 4.00 (0.68) 12.=0.86) 13.58) 8.78 (0.69) 11.40) 5.10 (0.61) 8.60 0.20 (0.D.85 (0.D.72 (0.39 (0.77) 14.51) S.40 (0.53 (0.50 1.=0.29) 2.90) S.69 (0.81 (0.D.06 (0.45) 5.36 (0.91 (0.81) 9. 36.00 (0.50) 7.81) 14.87) 13.54 (0. 48.22 (0.60 0.D.57 (0.77) 15.62 (0.99 (0.02) 0.86) S.80 1.63 (0.D.50) 6.97 (0.40 S.77 (0.81 (0. 36.77 (0. 36.=0.36 (0.49) 6.39) 0.29 (0.14 (0.44 (0.74 8.81) S.D.24) 2.05 Price= 40.40 S.D.15 (0.64) 13.=0.50 (1. 36. Price 28. S.32) 2.20 S.23) 2.50 0.94) 13.58) 7.84 (0.=0.55 (0.30 (0.45 (0.73 (0.19 (0.42) 5.80 1.14 (0. 0.59) 6.31) 0. 32.90 1.83) 13.=0.00) 0.75 (0.42 (0. 32.20) 1.07 (0.97 (0.60) 5.27 (0.=0.06) 0.36) 4.23) 2.98) 0.44) 40.70 2.80 (0.89 (0.42 (0.02 (0.93) (0.80 (0.59 (0.D.47) 5.72) 11.09 (0. 3 Months R = 0.23 (0.93 (0.19) 1.D.98) 12.=0.11 (0.18 (0. 44.84 9.=0.D.28 (0.94) 13.81 (0. 52.41) 3.60) 8.79 (0.15 (0.67 (0.=0.09) 0.02) 0.04) 0.=0.68) 11.11 (0.16 (0.22 (0.61) 6.78) 10.99 (0.92 (0.89 (0.57 6.D.66 (0.41 (0.82) 9.71) 10.28 (0.96 (0.48) S.94 (0.70 1.40 S.82) S.12 (0.72 (0.82) 13.44 (0.) 14.88) 13.19) 1.D.73) 10.32 (0.69) 13.98) 0.44) 5.D.23 (0.75) 16.

04) 0.64 (0.20 0.90 (0.25 (0.72) 15.35 (0.89) 14.82 (0.11 (0.66) 6.92) 6.73) 7.90 4.80 3.82) S.05 S.47 (0.54 (0.D.70 3.49) 4.=0.62) 10.=0.12 (0.80) 13.26 (0.39 (0.02 (0.53) 40.=0.99) 0.26) 2.=0.29 (0.70) 14.49) 6.70 (0. 36.13 (0.85 (0.43 (0.70 2.71) 15.90 5.91 (0.D.89 (0.62) 8.41) 5.40 (0.66) 12.53) 8.D.84) 14.51) 7.49 (0.84) 9.58 (0.80 4.48) 6.33) 3.67 (0.88 (0.35) 4.68) 14.77) 19.27 (0.14 (0. 36.10 S.79) 15.55 (0.59 (0.41 (0.20 S.75 (0.32 (0.59 (0.86) 11.04 (0.79) S.57) 9.01 (0.01 (0.27) 2.02 (0.D.57) 9. 48.56 (0. 52.D.26 (0.42) 5.46 (0.60) S.D.=0.D.65) 9.03 (0.44) 5.44 (0.63) 7.51 (0.23 (0.46) 0.D.75) 12.72) 15.11 (0.79 (0.D.82) 16.04 (0.=0.92 (0.87 (0.80) S.97) 0.30 (0.75) 17.11 (0.D. Price= 40.=0.82 (0.83 (0.22) 2.74) 11.45 (0.99 (0.38 (0.95 (0.83 (0.26 (0.20 0.55) 8.85 (0.36 (0.37) 3.22 (0.33) 3. Option Values and Hedge Ratios for Different Stock Prices and Standard Deviations.30 S.65 (0.81) S.20 S.03 (0.60 2.14 (0.56) 10.D.=0.24) 2.71 (0.77) 20. 44.76) 17.77 (0.22 (0.15 (0.19 (0.70 3.65) 9.51 (0.97 (0.D.=0.14) 1.82) S.D.76) 22. 52. by Maturity and Interest Rate.=0.40 S.71) 11.86 (0.10 (0.28) 2.30) 3.D.53) 8.75) 18.19 (0.78) 11. 44.48) 7.54) 6.07 (0.=0. 32.D.69 (0.23) 2.79 (0.50 (0.62 (0.41 (0.73 (0.02 (0.75) 19.67 (0.94) 14.13 (0.33 (0.82) 16.71) 13.58) S.43 (0.24 (0.58 (0.35 (0.70) 13. Exercise Price= 40.94) 0.72) 16.30) 3.49 (0.90) 10.17 (0.80 3.83 (0.72) 16.68) 7.78) S.10 Exercise S.40 S.40 (0.87) 15.97 (0.36) 4.64) 12.60 (0.31 (0.42 (0.82) 10.67) 13.81 (0.70 (0.67) 13.70) 7.12 (0.50 1. 4.58) 10.D.49) 7.44) 4.62) 12.85) 15.66) 8.52) 8.21 (0.09 (0.67) 15. 32.69 (0.73 (0.56) 8.59 (0.16 (0.65) 10.30 0.70 (0.47 (0.58 (0.51) 6.30 S.55) 9.80) 11.91) 15.22 (0.75) 20.79) 10.59 (0.83) S.91 (0.16) 1.80) 15.92 (0.96 (0.24 (0.56 (0.60 (0.99) 0.40 (0. 32.66) 8. Exercise Price= 40.D.=0.96 (0. 32.39) 4.75) 21. 48.91 (0.23 (0.78) S.55) 8.58) 10.59 (0. 6 Months R = 0.38 (0.83) 14. 48.52) 7.90 5.90) 1.92 (0.62 (0.62) S.64) Price 28.81) S.60 1.D.=0.90 4.59) 10.51) 5.45) 6.58 (0.61) 8.43) 6.93 (0.17) 1.02 (0.02 (0.=0.49) 7.=0.30 S.80) S.61) 7.73) 13.26 (0.12) 1.02) 0.17) 1.=0.96) 0.11) 1.45 (0.=0.44 (0.45) 6.37 (0.50 1. 6 Months R = 0.72) 17.37 (0.28) 2.56) S.50) 7.51 (0.18 (0.88 (0.61) 11.71) 18.79) S.=0.=0.51) 1.06 (0.50 1.49 (0.=0.33 (0.46) 6.70) 17.04 (0. 48.50 (0.49 (0.37 (0.46 (0.49) 6.70 2.D.73) 13.64) 11. 40.72 (0.76 (0.D.=0.74) 10.72) 14.60) 11.80 (0.12 (0.45 (0.10 (0.=0.22 (0.79) 17. 40.41 (0.69) 16.59) 10.08 (0.=0.01 (0.11 (0.41 (0.16) 1.=0.79) FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 OJ71 .87 (0.77) 16.80) 9.45) 4.D.91 (0.23 (0.92 (0. Exercise Price= 40.D.07 (0.11 (0.66) 12.51) 8.D.06) 0.95 (0.15 S.25 (0.78) 16.88 (0.77) 18.60 3.36 (0. 44.73) 19.76 (0.D.=0.45) 5.32) 3.40) 4.66) 11.03) 0.13 (0.29 (0.44) 3.63) 11.98) 5.75 (0.60 2.D.52) 8.D.=0.72 (0.96 (0.D. 9 Months R = 0.95 (0.48) 5.85 (0.91) 13.64) 12.62 (0.76) 18.89) S.38 (0. 44.44 (0.79) 17.21 (0.26 (0.49 (0.76) 20.86) 10.40 0.24 (0.38) 4.37) 4.40) 4.65 (0.71) 16.77) 19.82) 11.71 (0.27 (0.05 (0.82 (0.30 (0.65) 13.84 (0.=0.D.=0.87) S.38) 3.61 (0.80 4.62) 9. 36.33) 3.25 (0. 52.66 (0.19 (0.09) 0.54 (0.D.86) S.05 (0.85) Price 28.70) 15.20 (0.53) 7.47 (0.50 2.08 (0.D.25 (0. 36.23 (0.71) 14.63) 10.07 (0.24) 2.20) 1.-0.96) 13.D. (Continued) Price 28.33 (0.77) 12.72) 12.59 (0.36) 3.21 (0.21 (0.35) 3.83 (0.42) 5.60 (0.=0.80) S.D.97) 14.40 S.34 (0. 40. 9 Months R = 0.76 (0.18 (0.08 (0.32 (0.78 (0.91) Price 28.=0.66) 14.46) 6.=0.58 (0.62) 6. 52.87) 8.40) 5.TABLE3.42 (0.64 (0.84 (0.60 (0.80 (0.84) S.65) 10.35 (0.45) 5.41) 5.98 (0.81 (0.78) 18.74) 12.60 (0.55 (0.

06 (0. S.77) 8. 141-183. In fact.52 (0. 5. and Myron Scholes.76) 14.=0.70) 16."Business Week (December 22.000 in certificates of deposit will earn interest.90) S.D. and Sheen T.=0. For descriptions of options trading. For some refinements and extensions. 1973)." Bell Journal of Economics and Management Science (Spring 1973).84) S.30) 3.27 (0. 72 D FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1975 .=0.85 (0.67 (0. by Maturity and Interest Rate.44) 5.21) 1. see "New Game in Town" (1974).15 ExercisePrice= 40. see Black (1971).59) 8.82) S. "New Game in Town. This method is only an approximation.=0.67 (0. pp.49 (0.D. Black. 1973). see Merton (1973. I am using "speculative" and "conservative"as I take them to be used in ordinary language as related to investments. and Malkiel and Quandt (1969).63 (0.D.69) 15.80 5. this assumption gives a value that is very close to the correct value.D. p.66) 13.36) 4.D.09) 0. and will neither be increased nor decreased.76 (0. When he has no short positions.75) 16.90) 16. and Richard E.74) 18.58) 7. it may be possible to create a hedge that is long stock and short options and that shows losses only for large increases in the stock price.42 (0.42) 5.79) 20.56) 6.02 (0.87 (0. see Merton (1973).62) 11.90 6. .=0.81) S. The net money in a position is the value of any stock or options long in the investor's account minus the value of any stock or options that he is short. 1. New York: Random House.42 (0.70 4. and "The Values in Options" (1973) listed under References.93 (0.55) 5.62 (0.000. For options that expire in less than a year.43 (0.31 (0. Walter. Malkiel.55) 8.62 (0. Fischer. 40. 36.52) 7.30 (0. (Continued) 9 Months R= 0.that the options are priced according to the formula. "The Only Game in Town.31 (0.61) 10. 3.44 (0. For extensive discussions of the role of information trading in determining a market maker's spread. 399-417. "Option Plays Are Spreading" (1973). Cambridge. 52. Parts I and II (July/August and November/December 1971).74) 17.60 3. Fischer.50 2. 11.57) 9.90) 12. Option Values and Hedge Ratios for Different Stock Prices and Standard Deviations. and use the one that gives the highest value. 1969." (May/June 1973). 7. 32. "The Valuation of Option Contracts and a Test of Market Efficiency.02 (0.68) 12.74) 19.61 (0.40 (0. Thorp. 89. 8.94) S.33 (0. "Option Plays Are Spreading. his net money is just the value of the stock or options in his account. pp. pp. Quandt.69) 14. 2.29) 2.12 (0.68) 11.=0.64 (0.60) 11. 12.78) 21. Black.24 (0. so the possible loss in the option position is even less than $1.Massachusetts:MIT Press.16 (0. 637-654.50) 7. Beat the Market. 9. or long two-option contracts and short one round lot of stock.54 (0. For a discussion of the factors affecting the quality of the market for a stock.71) 9.30 0.60 (0.85 (0.50 (0.78) 13.99) S.94 (0. More precisely. Robert G. p.28 (0.20 (0.93 (0.D.81) Footnotes 1. When there is a possibility that the option will be exercised before an early ex-dividend date. References Bagehot.21 (0. Edward 0. the position is short two-option contracts and long one round lot of stock. Strategies and Rational Decisions in the Securities Options Market.84 (0.73 (0.39 (0. In this paragraph. It assumes that the dividend is known for sure. If they are overpriced.39 (0.82) 18.20 0. 10. 44.69) 10. p." Financial Analysts Journal (March/April 1971). "The Values in Options. For a proof of this. see Bagehot (1971) and Black (1971).22 (0.72 (0. See Black and Scholes (1972. "The Pricing of Options and Corporate Journal of Political Economy Liabilities. 4.=0.83 (0.53) 8.01 (0.TABLE3.35 (0.48 (0. pp. 1967.38) 3.82) 12.40 1. and the current OCC Prospectus.96) 16.82 (0.64) 12." Journal of Finance (May 1972). Burton G." Fortune (November 1973)." Financial Analysts Journal. This assumes. pp. Price 28. Writing naked options is writing options without holding the underlying stock.D.=0. Merton. we do calculations assuming expiration just before every ex-dividend date.D.94 (0.56 (0. 6. "Theory of Rational Option Pricing.48) 6." Wall Street Journal (April 22.85) 17. 13. 1974). "Toward a Fully Automated Exchange.86) S.27 (0. Relevant books include Thorp and Kassouf (1967).80) 19. Kassouf.46) 6. 104.07 (0. 12-15.28 (0. 48. 151156).78) 22.30 (0. the $3.22 (0.