Ch10HullOFOD9thEdition (4).ppt

Chapter 10
Mechanics of
Options Markets
Options, Futures, and Other Derivatives, 9th Edition, Global Edition,
Copyright © John C. Hull 2018 1

Review of Option Types
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

Option Positions
Long call
Long put
Short call
Short put

Long Call (Figure 10.1, Page 236)
Profit from buying one European call option: option
price = $5, strike price = $100, option life = 2 months
30
20
10
0
-5
70 80 90 100
110 120 130
Profit ($)
Terminal
stock price ($)

Short Call (Figure 10.3, page 238)
Profit from writing one European call option: option
price = $5, strike price = $100
-30
-20
-10
0
5
70 80 90 100
110 120 130
Profit ($)
Terminal
stock price ($)

Long Put (Figure 10.2, page 237)
Profit from buying a European put option: option
price = $7, strike price = $70
30
20
10
0
-7
70
60
50
40 80 90 100
Profit ($)
Terminal
stock price ($)

Short Put (Figure 10.4, page 238)
Profit from writing a European put option: option price
= $7, strike price = $70
-30
-20
-10
7
0
70
60
50
40
80 90 100
Profit ($)
Terminal
stock price ($)

Payoffs from Options
What is the Option Position in Each Case?
K = Strike price, ST = Price of asset at maturity
Payoff Payoff
ST ST
K
K
Payoff
Payoff
ST ST
K
K

Assets Underlying
Exchange-Traded Options
Page 239-240
Stocks
Foreign Currency
Stock Indices
Futures

Specification of
Exchange-Traded Options
Expiration date
Strike price
European or American
Call or Put (option class)

Terminology
Moneyness :
At-the-money option
In-the-money option
Out-of-the-money option

Terminology
(continued)
Option class
Option series
Intrinsic value
Time value

Ways the CBOE Is Trying to Take
Market Share from the OTC Market
Flex options
Binary options
Credit event binary options (CEBOs)
Doom options

Dividends & Stock Splits
(Page 243-244)
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 similarly to stock
splits

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?

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

Margins (Page 246-248)
Margins are required when options are sold
When a naked option is written the margin is the
greater of:
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
A total of 100% of the proceeds of the sale plus
10% of the underlying share price (call) or
exercise price (put)
For other trading strategies there are special rules

Warrants
Warrants are options that are issued 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

Warrants
(continued)
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
usually lead to new treasury stock being
issued

Employee Stock Options (see also Chapter 16)
Employee stock options are a form of
remuneration issued by a company to its
executives
They are usually at the money when issued
When options are exercised the company
issues more stock and sells it to the option
holder for the strike price
Expensed on the income statement

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
Usually 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

Ch10HullOFOD9thEdition (4).ppt

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