Transcript Options
Financial Derivatives Greater Gains Greater Risk • • • • Forward Futures Options Swaps • These are the most common Financial Derivatives • Recall • Owning a stock is owning growth • Owning a bond is owning debt • Options • Call Option the right to buy at a specified price • Put Option the right to sell at a specified price • A stock option is a privilege to buy or sell a stock at an agreed-upon price within a period of time Stock Options • Investor buys a call option (Bullish trade) • Now owns the right to buy the ‘underlying asset’ at a specified price within a given time frame (maturity) • Investor sells a call option • ‘Bearish’ trade • Assumes the obligation to supply the underlying asset Call Option • Investor buys a put option (Bearish) • Investor now owns the right to sell a specified amount of an underlying security at a specified price within a time frame (maturity) • Put options are great for hedging when purchasing a security • Selling a put option is bullish Put Option • Option contracts all have expiration dates • Just as most derivatives • Options have value until expiration • After that, they are worthless • Options with longer time until maturity will be more expensive Price Factors: Time • Strike Price affects the premium (Intrinsic + Extrinsic [time value] because the strike price is the location of the value • Whether it contains intrinsic value, extrinsic value or both Price Factors: Strike Price ITM, OTM and ATM • A strike price that is below the current market price for a security is to be considered in the money • In the money trades mostly like a stock position • Relative to the difference between the strike price and underlying • ITM options require a smaller price move in the underlying in order to be profitable • The downside is that the percentage gain will not be as large • ITM options have the most intrinsic value In the ‘Money’ • The strike price of the option is equal to the underlying price • ATM option has the greatest uncertainty • Uncertainty is the risk associated • ATM can be the worst position if everything moves against you • Can also result in massive gains • ATM can hurt you the most if the underlying moves in the direction opposite of what you hoped At The ‘Money’ • OTM options require a large move in order to be profitable • A move large enough in the direction you want it too, the OTM option can deliver large gains • But if the move is against you, the loss will be less than ATM and ITM • OTM near expiration dates tends to fare well Out of the ‘Money’ • The actual value of a company or an asset based on an underlying perception of its’ true value including all aspects of business Intrinsic Value • The difference between an option’s market price (current price) and its’ intrinsic value • It is also the portion of an item’s worth that is determined by external factors • Extrinsic Value is typically time value of an option • For example: • An option premium price of $10 with an intrinsic value of $9, the extrinsic value is $1 Extrinsic Value • Buy (Long) call • bullish • Sell (Short) Call • bearish • Buy Put • bearish • Short Put • bullish • If your option doesn’t obligate you to something, the risk is less • Shorting an option is riskier, but can pay out big Option Strategies •Pattern • a combination of qualities, acts, tendencies, etc., forming a consistent or characteristic arrangement