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Chapter 24Fundamentals of Corporate FinanceThird Edition
Options
Brealey Myers Marcus
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
Put Option
Right to sell an asset at a specified exercise
price on or before the exercise date.
Call Option
Right to buy an asset at a specified exercise
price on or before the exercise date.
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Option Obligations
B u y e r S e l l e r
C a l l o p t i o n R i g h t t o b u y a s s e t O b l i g a t i o n t o s e l l a s s e t
P u t o p t i o n R i g h t t o s e l l a s s e t O b l i g a t i o n t o b u y a s s e t
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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 $30
0000510V a l u ePu t
25155000V a l u e C a l l
4540353025$20eSt o c k P r i c
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Option Value
Call option value (graphic) given a $30 exercise price.
Share Price
Ca
ll opt
ion
va
lue
30 40
$10
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Option Value
Put option value (graphic) given a $30 exercise price.
Share Price
Pu
t o
ptio
n v
alu
e
25 30
$5
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Option Value
Call option payoff (to seller) given a $30 exercise price.
Share Price
Ca
ll opt
ion
$ pa
yof
f
30
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Option Value
Put option payoff (to seller) given a $30 exercise price.
Share Price
Pu
t o
ptio
n $ pa
yof
f
30
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Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alu
e
Long Stock
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Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alu
e
Long Put
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Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alu
e Protective Put
Long Put
Long Stock
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Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alu
e Protective Put
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alu
e Long call
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alu
e
Long put
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alu
e
Straddle
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alu
e
Straddle
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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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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.