Chapter 23

Fundamentals of
Corporate
Options
Finance

Fifth Edition

Slides by
Matthew Will

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Topics Covered

Calls and Puts

What Determines Option Values
Spotting the Option

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Option Terminology

Call Option
Right to buy an asset at a specified exercise
price on or before the exercise date.

Put Option
Right to sell an asset at a specified exercise
price on or before the exercise date.

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Option Obligations

Buyer Seller
Call option Right to buy asset Obligation to sell asset
Put option Right to sell asset Obligation to buy asset

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Option Value
 The value of an option at expiration is a function of
the stock price and the exercise price.

Example - Option values given a exercise price of $180

Stock Price $140 160 180 200 220

Call Value 0 0 0 20 40
Put Value 40 20 0 0 0

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Option Value
Call option value (graphic) given a $180 exercise price.
Call option value

$40

180 220
Share Price
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23- 7

Option Value
Put option value (graphic) given a $180 exercise price.
Put option value

$40

140 180
Share Price
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23- 8

Option Value
Call option payoff (to seller) given a $180 exercise price.
Call option $ payoff

180
Share Price
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23- 9

Option Value
Put option payoff (to seller) given a $180 exercise price.
Put option $ payoff

180
Share Price
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23- 10

Option Value
Protective Put - Long stock and long put
Long Stock
Protective Put
Position Value

Long Put

Share Price
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Option Value
Protective Put - Long stock and long put

Protective Put
Position Value

Share Price
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility

Long put
Position Value

Long call
Straddle

Share Price
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Position Value

Straddle

Share Price
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Option Value
Stock Price
Upper Limit

Lower Limit

(Stock price - exercise price) or 0

which ever is higher

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Option Value
Components of the Option Price
1 - Underlying stock price
2 - Striking or Exercise price
3 - Volatility of the stock returns (standard deviation of
annual returns)
4 - Time to option expiration
5 - Time value of money (discount rate)

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Option Value

Black-Scholes Option Pricing Model

OC = Ps[N(d1)] - S[N(d2)]e-rt

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23- 17

Options on Real Assets

Real Options - Options embedded in real assets

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Options on Real Assets

Real Options - Options embedded in real assets

Option to Expand

Option to Abandon

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Options on Financial Assets

Warrants - Right to buy shares from a company at a
stipulated price before a set date.
Convertible Bond - Bond that the holder may
exchange for a specific number of shares.
Callable Bond - Bond that may be repurchased by
the issuer before maturity at specified call price.

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