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Call & Put Options

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Jemma Rethman

on 9 July 2015

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Transcript of Call & Put Options

Call & Put Options
OPTION STRATEGIES V - Collars
In/ Out of/ At the money
Strike Price
The price that the buyer of option is able to buy or sell the asset for.
Trading of Call & Put Options
Trading of options began in 1973

Chicago Board Options Exchange began listing call options


Why are options traded?
Leverage

Limited Risk
Price of an Option is based on...
- The stock price
- Time left until the option expires
- Volatility of the underlying stock
- Liquidity (bid/ask spread)
OPTION STRATEGIES IV - Spreads
Jemma Rethman
Presentation Outline
I. Call and Put Options Basics
II. The trading of Calls and Puts
III. Why trade options?
IV. Option Strategies
WHAT IS AN OPTION?
+ Derivative
+ A contract between two parties

Premium
How much the buyer of the option pays to the seller.
Much like an insurance premium.
SOURCES

http://investorplace.com

http://www.theoptionsguide.com/

Bodie, Zvi, Kane, Alex and Marcus, Alan J. Essentials of Investment 8th Edition. 2010.
Over the Counter Markets
Organized Exchanges
OPTION STRATEGIES I - Protective Put
OPTION STRATEGIES II - Covered Call
QUANTITATIVE QUESTION
~ Calls
QUANTITATIVE QUESTION
~ Puts
REAL LIFE EXAMPLE
SOLUTION
SOLUTION
An investor buys a call at a price of $4.50 with a strike price of $40.

At what stock price will the investor break even on the purchase of the call?
$4.50 + $40 = $44.50

Premium + Strike Price =
Break-even Price
You purchase one IBM March 100 put contract for a premium of $6.47.

What is your maximum possible profit?
If the stock price drops to $0.
$100.00 - $6.47 = $93.53

A contract is for 100 shares, therefore your maximum possible profit is $93.53 x 100 = $9,353

Hedging
CALL

Value at expiration (final value) = underlying price - strike price
Final value must be 0 or above 0
Profit = final value - original investment (premium)

PUT

Value at expiration (final) = strike price - underlying price
Final value must be 0 or above 0
Profit = final value - original investment (premium)
Options contract (strike price, expiration date, number of shares) can be made to fit the needs and wants of the buyers and sellers.

But...high costs
Standardized option contract terms (set strike prices, expiration dates and numbers of shares). Ex: A contract is for the right to buy or sell 100 shares of stock.

Therefore...lower trading cost and a more competitive market
OPTION STRATEGIES III - Straddle
Buy a stock and a put option on the same stock

This guarantees that the minimum payoff will equal the put's exercise price and a max. loss of the premium

If the stock price falls, your put will be worth something
Sell the stock for a higher price than the market

If the stock increases you can sell your stocks for more, let the put expire and lose the premium



Buy a stock and write a call option on the same stock

The potential obligation of delivering the stock is
covered
by the stock already in the portfolio

Income is boosted by the premiums collected.
A combo of a call and put, each with the same exercise and expiration date

Used when investors strongly believe that a stock price will move, but are not sure of the direction


A combo of two or more call options or put options on the same asset with differing exercise prices or times to expiration

Money spread
- purchase of one option and the simultaneous sell of another with a different exercise price

Time spread
- sale and purchase of options with differing expiration dates
Brackets a portfolio between two bounds

Limits loss but also limits gain
http://www.investopedia.com/video/play/hedging/
EXAMPLE:
Bought 100 shares for $89/ share and a put (for 100 shares) for $200. Initial investment $8900+$200
=
$9100

IF
Strike Price = $90
Premium = $2/ share
Stock Price = $87 --> Sell stock for $90 -$2 premium
--> $88 x 100 = $8800 -->
Loss of $300

IF
Strike Price = $90
Premium = $2/ share
Stock Price = $94 --> Sell stock for $94 (put expires - $2)
--> $92 x 100 = $9200 -->
Profit of $100
Bets of volatility (how much the price of the stock moves)


EXAMPLE: Own
1,000
shares of IBM
Current Price =
$120
Intend to sell if price hits
$130
/share
A call expiring in 3 months with an exercise price of $130 sells for
$5
Write 10 IBM call contracts -->
$5000 income
If stock price rises above $130, lose share of profits, but keep premium
Usually used when an investor thinks that one option is over priced relative to another.
EXAMPLE: Imagine you want to buy a house for $160,000. Your current wealth is $140,000 and you are unwilling to lose more than $20,000.
You can buy 2000 shares of stock at $70/share and 2000 put options (20 option contracts) with an exercise price of $60 and you can write 2000 calls with an exercise price of $80.
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