InvestmentsHull2022 04

Chapter 11
Properties of Stock Options
Options, Futures, and Other Derivatives, 11th Edition, Copyright © John C. Hull 2021
1
Notation
c: European call option C: American call option
price price
p: European put option P: American put option
price price
S0: Stock price today ST: Stock price at option
K: maturity
Strike price
D: PV of dividends paid
T: Life of option
during life of option
s: Volatility of stock
price r Risk-free rate for
maturity T with cont.
comp.
Options, Futures, and Other Derivatives, 11th

Edition, Copyright © John C. Hull 2021 2
Effect of Variables on Option
Pricing (Table 11.1)
Variable c p C P
S0 + − + −
K − + − +
T ? ? + +
s + + + +
r + − + −
D − + − +
Options, Futures, and Other Derivatives, 11th Edition,

Copyright © John C. Hull 2021 3
American vs European Options
An American option is worth at least as much
as the corresponding European option
Cc
Pp

Lower Bound for European Call
Option Prices; No Dividends
(Equation 11.4)
c  max(S0 –Ke –rT, 0)

Lower Bound for European Put
Prices; No Dividends (Equation 11.5)
p  max(Ke -rT–S0, 0)

Put-Call Parity: No Dividends
Consider the following 2 portfolios:

Portfolio A: European call on a stock + zero-
coupon bond that pays K at time T
Portfolio C: European put on the stock + the stock

Values of Portfolios (Table 11.2)
ST > K ST < K
Portfolio A Call option ST − K 0
Zero-coupon bond K K
Total ST K
Portfolio C Put Option 0 K− ST
Share ST ST
Total ST K

The Put-Call Parity Result (Equation
11.6)
Both are worth max(ST , K ) at the maturity of
the options
They must therefore be worth the same
today. This means that c + Ke -
rT
= p + S0

Early Exercise
Usually there is some chance that an
American option will be exercised early
An exception is an American call on a non-
dividend paying stock
This should never be exercised early

Bounds for European or American Call
Options (No Dividends) Figure 11.3

Bounds for European and American
Put Options (No Dividends) Figure 11.4

The Impact of Dividends on Lower
Bounds to Option Prices
(Equations 11.8 and 11.9)

Extensions of Put-Call Parity
American options; D = 0
S0 − K < C − P < S0 − Ke−rT
Equation 11.7
European options; D > 0
c + D + Ke −rT = p + S0
Equation 11.10
American options; D > 0
S0 − D − K < C − P < S0 − Ke −rT
Equation 11.11

Chapter 12
Trading Strategies Involving
Options
Options, Futures, and Other Derivatives,

11th Edition, Copyright © John C. Hull 2021 15
Strategies to be Considered
Bond plus option to create principal
protected note
Stock plus option
Two or more options of the same type (a
spread)
Two or more options of different types (a
combination)

Principal Protected Note
Allows investor to take a risky position without
risking any principal
Example: $1000 instrument consisting of
3-year zero-coupon bond with principal of $1000
3-year at-the-money call option on a stock portfolio
currently worth $1000

Principal Protected Notes continued
Viability depends on
Level of dividends
Level of interest rates
Volatility of the portfolio
Variations on standard product
Out of the money strike price
Caps on investor return
Knock outs, averaging features, etc

Positions in an Option & the Underlying
(Figure 12.1)
Profit Profit
K
K ST ST
(a)
(b
Profit Profit )
K
ST K ST
(c (d
Options, )Futures, and Other Derivatives, 11th Edition,)
Bull Spread Using Calls
(Figure 12.2)
Profit
ST
K1 K2

Bull Spread Using Puts
Figure 12.3
Profit
K1 K2 ST

Bear Spread Using Puts
Figure 12.4
Profit
K1 K2 ST

Bear Spread Using Calls
Figure 12.5
Profit
K1 K2 ST

Box Spread
A combination of a bull call spread and
a bear put spread
If all options are European a box spread
is worth the present value of the
difference between the strike prices
If they are American this is not
necessarily so (see Business Snapshot
11.1)
A Straddle Combination
Figure 12.10
Profit
K ST

Butterfly Spread Using Calls
Figure 12.6
Profit
K1 K2 K3 ST

Butterfly Spread Using Puts
Figure 12.7
Profit
K1 K2 K3 ST


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Chapter 11

Properties of Stock Options

Options, Futures, and Other Derivatives, 11th

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

c  max(S0 –Ke –rT, 0)

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Consider the following 2 portfolios:

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

Options, Futures, and Other Derivatives, 11th Edition,

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