Lecture13 - Fundamentals of Options

Basics Buy Call at Expiration Inputs Buy or Sell: 1 = Buy, -1 = Sell 1 Option Type: 1=Call, 2=Put 1 Exercise (Strike) Price $40.00 Option Price (Premium) $5.00 red line - option profit blue line - option payof Outputs Stock Price At Maturity $0.00 $8.00 $16.00 $24.00 $32.00 $40.00 $48.00 $56.00 $64.00 $72.00 $80.00 Option Payoff $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $8.00 $16.00 $24.00 $32.00 $40.00 Option Profit -$5.00 -$5.00 -$5.00 -$5.00 -$5.00 -$5.00 $3.00 $11.00 $19.00 $27.00 $35.00 Key points 1. Observe profit patterns for buyer and seller of a call 2. Observe profit patterns for buyer and seller of a put 3. Find breakeven price for the buyer of call or put option 4. Change option price, observe changes in payoff and profit and break even price O PTION P AYOFFS AND P ROFITS $0 $10 $20 $30 $40 $50 $60 $70 $80 -$40 -$20 $0 $20 $40 Option Payoffs and Profits Stock Price At Maturity Payoff and Profit Suppose an option to buy o sell a single share costs $5 And the exercise price in th option contract is $40. Wha are the option's payoffs and profit if it is held to maturity For option bought: Option Profit = Option P For option sold (written Option Profit = Option P

ff <--see formula <-see formula or 5.00. he at d Payoff - premium n): Payoff + premium

Call Option Payoff Patterns Time 0 Time T Put Option Payoff Patterns Time 0 Time T Purchase call option, cash flow < 0 Terminal call payoff, Max[S T - K,0] > 0 Between times 0 and T: Cash flow = 0 for European option Cash flow > 0 for American option Write (I.e., issue) call option, cash flow > 0 Pay terminal call payoff = - Max[S T - K, 0] < 0 Between times 0 and T: Cash flow = 0 for European option Cash flow < 0 for American option Purchase put option, cash flow < 0 Terminal put payoff, Max[K - S T ,0] > 0 Between times 0 and T: Cash flow = 0 for European option Cash flow > 0 for American option Write (i.e., sell) call option, cash flow > 0 Pay terminal call payoff = - Max[K - S T , 0] < 0 Between times 0 and T: Cash flow = 0 for European option Cash flow < 0 for American option