59d ago

week 28 Options: Puts and Calls

Options: Puts and Calls

Learning Goals

  • Understand the basics of options, puts, and calls.

  • Describe the options market, including strike prices and expiration dates.

  • Explain option valuation and the factors influencing option prices.

Call and Put Options

  • Financial Assets: Claims on an issuing organization (e.g., stocks, bonds).

  • Option: Right to buy/sell an underlying asset at a fixed price for a limited time (e.g., calls, puts).

Basic Features of Calls and Puts

  • Call: Right to buy stock at the strike price.

  • Put: Right to sell stock at the strike price.

  • Derivative Securities: Options (and futures) derive value from the underlying asset.

  • Option holders have no voting rights or ownership privileges.

  • Option Premium: Price paid to buy an option.

  • Options provide leverage, allowing investors to benefit from price movements with less capital.

Seller vs. Buyer

  • Options are created by investors, not the underlying asset issuers.

  • Option Seller (Writer):

    • Receives premium upfront.

    • Obligated to sell (call) or buy (put) the asset.

  • Option Buyer:

    • Right to buy (call) or sell (put) at the strike price for a period.

    • Pays the option premium.

    • Can choose not to exercise the option.

  • Options trade in the open market.

How Calls and Puts Work

  • Call:

    • Buyer wants the underlying asset price to increase.

    • Seller wants the underlying asset price to decrease.

  • Put:

    • Buyer wants the underlying asset price to decrease.

    • Seller wants the underlying asset price to increase.

Advantages and Disadvantages

  • Advantages:

    • Leverage: potential for large profits from small price movements.

    • Profit from rising or falling prices.

  • Disadvantages:

    • No interest or dividend income, no ownership benefits.

    • Options expire, limiting the time to profit.

    • Risky: price changes can render options worthless.

Stock Options

  • Expiration Date: Date option expires.

  • American Options: Exercisable any time up to expiration.

  • European Options: Exercisable only on the expiration date.

  • U.S. exchange-listed options are American options.

Options Pricing and Trading

  • Option value depends on the underlying asset's price.

  • Other factors: time to expiration, stock volatility, interest rates.

  • Price potential on a call is unlimited. Price potential on a put is limited because stock price can't go below 00$$0$$.

Intrinsic Value

  • Determined by the relationship between strike price and market price.

  • In-the-Money:

    • Call: strike price < market price.

    • Put: strike price > market price.

    • Intrinsic value is greater than zero.

  • Out-of-the-Money:

    • Call: strike price > market price.

    • Put: strike price < market price.

  • At-the-Money: strike price = market price.

Put-Call Parity

  • Put and call options with the same asset, strike price, and expiration date cannot move independently.

  • Put-Call Parity: Portfolios with a put and stock share payoffs with a portfolio containing a call and risk-free bond.

  • Knowing the underlying stock price, risk-free rate, and call option price allows determining the put value.


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week 28 Options: Puts and Calls

Options: Puts and Calls

Learning Goals

  • Understand the basics of options, puts, and calls.

  • Describe the options market, including strike prices and expiration dates.

  • Explain option valuation and the factors influencing option prices.

Call and Put Options

  • Financial Assets: Claims on an issuing organization (e.g., stocks, bonds).

  • Option: Right to buy/sell an underlying asset at a fixed price for a limited time (e.g., calls, puts).

Basic Features of Calls and Puts

  • Call: Right to buy stock at the strike price.

  • Put: Right to sell stock at the strike price.

  • Derivative Securities: Options (and futures) derive value from the underlying asset.

  • Option holders have no voting rights or ownership privileges.

  • Option Premium: Price paid to buy an option.

  • Options provide leverage, allowing investors to benefit from price movements with less capital.

Seller vs. Buyer

  • Options are created by investors, not the underlying asset issuers.

  • Option Seller (Writer):

    • Receives premium upfront.

    • Obligated to sell (call) or buy (put) the asset.

  • Option Buyer:

    • Right to buy (call) or sell (put) at the strike price for a period.

    • Pays the option premium.

    • Can choose not to exercise the option.

  • Options trade in the open market.

How Calls and Puts Work

  • Call:

    • Buyer wants the underlying asset price to increase.

    • Seller wants the underlying asset price to decrease.

  • Put:

    • Buyer wants the underlying asset price to decrease.

    • Seller wants the underlying asset price to increase.

Advantages and Disadvantages

  • Advantages:

    • Leverage: potential for large profits from small price movements.

    • Profit from rising or falling prices.

  • Disadvantages:

    • No interest or dividend income, no ownership benefits.

    • Options expire, limiting the time to profit.

    • Risky: price changes can render options worthless.

Stock Options

  • Expiration Date: Date option expires.

  • American Options: Exercisable any time up to expiration.

  • European Options: Exercisable only on the expiration date.

  • U.S. exchange-listed options are American options.

Options Pricing and Trading

  • Option value depends on the underlying asset's price.

  • Other factors: time to expiration, stock volatility, interest rates.

  • Price potential on a call is unlimited. Price potential on a put is limited because stock price can't go below 00.

Intrinsic Value

  • Determined by the relationship between strike price and market price.

  • In-the-Money:

    • Call: strike price < market price.

    • Put: strike price > market price.

    • Intrinsic value is greater than zero.

  • Out-of-the-Money:

    • Call: strike price > market price.

    • Put: strike price < market price.

  • At-the-Money: strike price = market price.

Put-Call Parity

  • Put and call options with the same asset, strike price, and expiration date cannot move independently.

  • Put-Call Parity: Portfolios with a put and stock share payoffs with a portfolio containing a call and risk-free bond.

  • Knowing the underlying stock price, risk-free rate, and call option price allows determining the put value.