Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.1
Mechanics of
Options Markets
Chapter 7
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.2
Types of Options
? A call is an option to buy
? A put is an option to sell
? A European option can be exercised
only at the end of its life
? An American option can be exercised at
any time
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.3Assets Underlying
Exchange-Traded Options
Page 151-152
? Stocks
? Foreign Currency
? Stock Indices
? Futures
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.4
Specification of
Exchange-Traded Options
? Expiration date
? Strike price
? European or American
? Call or Put (option class)
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.5
Terminology
Moneyness,
–At-the-money option
–In-the-money option
–Out-of-the-money option
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.6
Terminology
(continued)
? Option class
? Option series
? Intrinsic value
? Time value
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.7Dividends & Stock Splits
(Page 154-155)
? Suppose you own N options with a strike
price of K,
– No adjustments are made to the option
terms for cash dividends
– When there is an n-for-m stock split,
? the strike price is reduced to mK/n
? the no,of options is increased to nN/m
– Stock dividends are handled in a manner
similar to stock splits
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.8
Dividends & Stock Splits
(continued)
? Consider a call option to buy 100
shares for $20/share
? How should terms be adjusted:
–for a 2-for-1 stock split?
–for a 5% stock dividend?
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.9
Market Makers
? Most exchanges use market makers to
facilitate options trading
? A market maker quotes both bid and
ask prices when requested
? The market maker does not know
whether the individual requesting the
quotes wants to buy or sell
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.10Margins
(Page 158-159)
? Margins are required when options are sold
? When a naked option is written the margin is the
greater of:
1 A total of 100% of the proceeds of the sale plus
20% of the underlying share price less the
amount (if any) by which the option is out of the
money
2 A total of 100% of the proceeds of the sale plus
10% of the underlying share price
? For other trading strategies there are special rules
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.11
Warrants
? Warrants are options that are issued (or
written) by a corporation or a financial
institution
? The number of warrants outstanding is
determined by the size of the original
issue and changes only when they are
exercised or when they expire
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.12
Warrants
(continued)
? Warrants are traded in the same way as
stocks
? The issuer settles up with the holder
when a warrant is exercised
? When call warrants are issued by a
corporation on its own stock,exercise
will lead to new treasury stock being
issued
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.13
Executive Stock Options
? Option issued by a company to
executives
? When the option is exercised the
company issues more stock
? Usually at-the-money when issued
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.14
Executive Stock Options
continued
? They become vested after a period ot
time
? They cannot be sold
? They often last for as long as 10 or 15
years
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.15
Convertible Bonds
? Convertible bonds are regular bonds
that can be exchanged for equity at
certain times in the future according to
a predetermined exchange ratio
Options,Futures,and Other Derivatives,5th edition ? 2002 by John C,Hull
7.16
Convertible Bonds
(continued)
? Very often a convertible is callable
? The call provision is a way in which
the issuer can force conversion at a
time earlier than the holder might
otherwise choose