FMI Madura C14

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Financial Markets and Institutions

Based on
Financial Institutions and Markets (9ed)
Jeff Madura

Taught by
Nguyen Thang
FPT School of Business (FSB)

Original Slides by
South-Western/Cengage Learning

© 2010 South-Western/Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1 © 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
Options Markets

Chapter Objectives

The specific objectives of this chapter are to:


■ explain how stock options are used to speculate,
■ explain why stock option premiums vary,
■ explain the use of stock index options, and
■ explain the use of options on futures.

© 2010 South-Western/Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2 © 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Background on Options

1. Call Option: right to buy underlying financial instrument at


exercise price (or strike price) within a specified period of time.
a. In the money with market price > exercise price
b. At the money when market price = exercise price
c. Out of the money when market price < exercise price
2. Put Option: right to sell underlying financial instrument at exercise
price (or strike price) within a specified period of time.
a. In the money when market price < exercise price
b. At the money when market price = exercise price
c. Out of the money when market price > exercise price

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Background on Options

1. Markets Used to Trade Options


a. Listing Requirements

b. Role of the Options Clearing Corporation (OCC)

c. Regulation of Options Trading

2. How Option Trades Are Executed


a. Floor Brokers

b. Market-Makers

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Background on Options

3. Types of Orders
a. Online Trading

4. Stock Option Quotations

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5 © 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Speculating with Stock Options

1. Speculating with Call Options

2. Speculating with Put Options

3. Excessive Risk from Speculation

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 14.2 Potential Gains or Losses on a Call Option:
Exercise Price = $115, Premium = $4

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Exhibit 14.6 Potential Gains or Losses on a Put Option:
Exercise Price = $110, Premium = $2

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Determinants of Stock Option Premiums

1. Determinants of Call Option Premiums


a. Influence of the Market Price

b. Influence of the Stock’s Volatility

c. Influence of the Call Option’s Time to Maturity

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Determinants of Stock Option Premiums

2. Determinants of Put Option Premiums


a. Influence of the Market Price

b. Influence of the Stock’s Volatility

c. Influence of the Put Option’s Time to Maturity

3. Explaining Changes in Option Premiums


a. Indicators Monitored by Participants in the Options Market

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Hedging with Stock Options

1. Hedging with Call Options

2. Hedging with Put Options

3. Using Options to measure a Stock’s Risk

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Options on ETFs and Stock Indexes

1. Hedging with Stock Index Options


a. Hedging with Long-Term Stock Index Options

2. Dynamic asset allocation with stock index options

3. Using index options to measure the market’s risk

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Options on Futures Contracts
1. Speculating with Options on Futures
a. Speculation Based on an Expected Decline in Interest Rates

b. Speculation Based on an Expected Increase in Interest Rates

2. Hedging with Options on Interest Rate futures

3. Hedging with Options on Stock Index Futures


a. Determining the Degree of the Hedge with Options on

Stock Index Futures

b. Selling Call Options to Cover the Cost of Put Options


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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Institutional Use of Options Markets

1. Options as Compensation
a. Distortion between Performance and Option Compensation

b. How Stock Option Compensation Can Destroy Shareholder


Value

c. Backdating Options

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Globalization of Options Markets

1. Currency Options Contracts


a. Calls and puts
b. When speculators expect a currency to depreciate,
they buy call options and a put option when they expect
appreciation.

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