Options: Call Option and Price Essay

Submitted By BLAHYUM
Words: 2512
Pages: 11
Open Document
CHAPTER 19
Options

REVIEW QUESTIONS

19-1. A call option is a short-term option to buy a specified number of shares at a stated price within a specified time period. A right is a corporate-created option to purchase a stated number of shares at a specified price within a specified period of time (usually within a few months).

A warrant is a long-term option created by a corporation that allows the holder to purchase a stated number of shares at a specified price within a specified period of time (usually a few years).

It is important to remember that call options are created by investors (individuals or institutions), while warrants and rights are created by corporations.

19-2. (a) Strike (exercise) price – the per-share price at which the common stock may be purchased or sold.

(b) Naked option – a call option written without the stock being owned by the writer, or a put option written by a writer who is not short the stock.

(c) Premium – the price paid by the option buyer to the writer or seller of the option (the market price of the option).

(d) Out-of-the-money option – a call whose exercise price exceeds the current stock price, or a put whose exercise price is less than the current stock price.

19-3. Investors, both individuals and institutions, write puts and calls in an attempt to profit from their beliefs about the underlying stock's likely price performance. Writers earn the premiums paid by the buyers.

19-4. Clearing corporations play an important role in the options market. They guarantee the performance of the contracts, preventing potential problems with writers who must honour their obligations. They also facilitate the taking of an opposite (closing) position at any time by buyers or sellers.

19-5. Option prices almost always exceed intrinsic values. This excess, sometimes called the premium over parity, exists because buyers are willing to pay some price for potential future stock price movements.
19-6. Option prices almost always exceed intrinsic values. The difference reflecting the option's potential appreciation is typically referred to as the time value. Time obviously has a positive value for call options because the longer the time to expiration for a call option, the more chance it has to appreciate.

19-7. Investors writing calls often are seeking the income from the premium. Such a strategy can supplement the dividend income on stocks held.

The obligation of a call writer is to deliver the stock for the strike price if called upon to do so.

19-8. An index option is a call or put option on a stock market index. Stock index options enable investors to trade on general stock market movements in the same way that they can trade on individual stocks.

Stock index options available in Canada include options on the TSE 35, the TIPS 35, and the TIPS 100. Soon, there will be an option on the S&P/TSE 60 Index.

19-9. The major differences between a stock index option and a stock option is that buyers of index options receive cash from the seller upon exercise of the contract. Stock options, in contrast, require the actual delivery of the stock upon exercise.

19-10. Writing covered calls is basically a conservative strategy. The writer forgoes (Renuncia) possible price appreciation while knowing what the likely gains are, whether the stock is called or not.

For a naked ( not owned by the writer) call writer, the potential gain is limited, while the potential loss is large.

19-11. To say an option is worth more alive than dead refers to the fact that it never pays to exercise an American call option on a non-dividend-paying stock early. Consider the holder of such an option who is ready to close out the position. The holder has two choices: exercise the call or sell it. It can be shown that the proceeds (ingresos) from the sale of the option exceed the proceeds from the exercise of the option. Thus, the option should be continued by selling it rather than
Show More

Related Documents: Options: Call Option and Price Essay

Investment: Options Essay

Theory and Investment Analysis • Options contracts • Pricing of the options contract • Investment strategies with options Lecture 8: Financial Derivatives Options contracts BKM: Chapters 20&21 1 2 Options Contracts 1. Options contract Learning objectives • Understand the basic terminology with options contracts. • Be able to calculate the profit/loss to various options positions as a function of ultimate security prices. • An option contact gives its holder the right to…

Words 2350 - Pages 10

Financial Options And Applications In Corporate Finance

Chapter 8 Financial Options and Applications in Corporate Finance 1 Topics in Chapter     Financial Options Terminology Option Price Relationships Black-Scholes Option Pricing Model Put-Call Parity 2 The Big Picture: The Value of a Stock Option Cost of equity (rs) D1 Stock Price = (1 + rs )1 Risk-free bond Dividends (Dt) D2 + (1 + rs)2 Portfolio of stock and risk-free bond that replicates cash flows of the option ... + D∞ + (1 + rs)∞ Value of option must be the same as the replicating…

Words 1955 - Pages 8

Essay on Class 6 Weekly Classes First Option C

BE332 - Class 6 - Options with Answers Multiple Choice 1) Which of the following options will yield a profit to the purchaser? a) An expired option that is "at the money." b) A call option when the price of the underlying asset increases above the option's strike price by an amount greater than the premium paid for the option. c) A put option when the price of the underlying increases above the option's strike price by an amount greater than the premium paid for the option. 2) Which statement…

Words 1378 - Pages 6

Case Studies In Finance

payment (or delivery of goods) whereby payment needs to be made. 1 4/9/2013 Who are users of derivatives  Hedgers – mainly interested in protecting themselves against adverse price changes – want to avoid risk  Speculators – hope to make money in the markets by betting on the direction of prices – “accept” risk  Arbitrageurs – arbitrage involves locking into riskless profit by simultaneously entering into transactions in two or more markets Hedge Funds vs. Mutual Funds…

Words 2220 - Pages 9

T5 tutans 1 1 1 Essay

question 21. We can use the Black-Scholes model to value the equity of a firm. Chapter 22 has a very thorough explanation how equity can be considered as a call or put. Using the asset value of $27,500 (the $26,300 current value of the assets plus the $1,200 project NPV) as the stock price, and the face value of debt of $25,000 as the exercise price, the value of the firm if it accepts project A is: d1 = [ln($27,500/$25,000) + (.05 + .552/2)  1] / (.55  ) = .5392 d2 = .5392 – (.55  ) = –.0108…

Words 1439 - Pages 6

Futures and Options Chapter 9 Answer Essay

CHAPTER 9 Mechanics of Options Markets Practice Questions Problem 9.8. A corporate treasurer is designing a hedging program involving foreign currency options. What are the pros and cons of using (a) the NASDAQ OMX and (b) the over-the-counter market for trading? The NASDAQ OMX offers options with standard strike prices and times to maturity. Options in the over-the-counter market have the advantage that they can be tailored to meet the precise needs of the treasurer. Their disadvantage…

Words 3045 - Pages 13

Option: Option and Stock Price Essay

Arbitrage, Delta neutral Strategy 3 1) Defined the Mispriced option 3 2) Risk neutral portfolio 4 3) Transaction cost 4 4) Summary of the strategy 5 5) Adjustments for the strategy 5 6) Close out the position 6 Further developed strategy 7 1) Develop strategy 7 2) Close out of the position 9 References: 11 Introduction Options are the derivatives of the underlying assets. Its value depends on the underlying assets. Like a stock, an option has its fair value and will be mispriced which gives…

Words 2297 - Pages 10

Solution: Futures Contract and Total Cost Essay

use the call option with the exeercise price $0.00756. The future price of Yen is expected to be $0.006912 which is much lower than the exercise price. The interest of the firm is to safeguard against any adverse movement in price and take advantage of price movement in expected direction. The volatility in the market has increases leading to higher cost of the option. The total option premium for option with exercise price $0.00756 is $1,890.00 The amount paid for yen if option is exercised…

Words 912 - Pages 4

Pricing Models: Position Option Cycle Model

CHAPTER 5: OPTION PRICING MODELS: THE BLACK-SCHOLES-MERTON MODEL END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. (A Nobel Formula) The formula has two terms: C = S0N(d1), is the present value of the expected value of the stock price, conditional on the option expiring in-the-money discounted at the risk-free rate. The second term, is the present value of the expected payout of the exercise price at the expiration. N(d2) is the probability of exercise. All of this is based on…

Words 2318 - Pages 10

Advantages And Cons Of Business Market

Chapter 1: Derivative: a contract between two parties providing for a payoff from one party to the other determined by the price of an asset, an exchange rate, a commodity price, or an interest rate. Derivative product is defined as financial contracts with settlement depending on the outcome of the underlying assets in the future. Advantages of OTC: terms can be tailored to specific needs of the parties, private market in which no one needs to know about the transactions, unregulated. Disadvantages…

Words 908 - Pages 4