Equity Options: An introduction - PowerPoint PPT Presentation

1 / 18
About This Presentation
Title:

Equity Options: An introduction

Description:

A derivate is a contract which derives its value from another: no value in itself. Yankee & Red Sox Fan agreement. No value unless both teams hit homeruns ... – PowerPoint PPT presentation

Number of Views:179
Avg rating:3.0/5.0
Slides: 19
Provided by: anthonyv1
Category:

less

Transcript and Presenter's Notes

Title: Equity Options: An introduction


1
Equity Options An introduction
  • By Anthony Vitiello
  • Portfolio Manager
  • Boston College Investment Club

2
Derivatives
  • A derivate is a contract which derives its value
    from another no value in itself
  • Yankee Red Sox Fan agreement
  • No value unless both teams hit homeruns
  • People can put capital at risk in two ways
  • Cash Market Buy asset in cash take delivery
  • Derivatives Market Buy a contract that mimics
    exposure to asset

3
So, what is an option??
  • By the book the right, but not obligation to buy
    or sell a certain asset at a fixed price by a
    certain date in the future
  • Two types
  • Call the right. to buy
  • Put the right.. to sell
  • Calls and puts are the building blocks for
    larger, complex trades

4
The Basics
  • Strike Price Price asset bought/sold
  • Expiration Date option is worthless
  • Underlying Stock option is based on
  • Premium Amount paid upfront for right
  • Quoted as dollars per share 100 shares
  • So if Mar 08 Apple 135 Calls are trading _at_ .40
  • That means, I can pay 40 (.40100 shares)
  • And have the right to buy 100 shares of Apple by
    Mar 08

5
Just some intuition
  • In general, if a stock prices rises
  • Calls increase in value because the right to buy
    stock at lower price (relative to initial) is
    worth more can seller for higher
  • Puts decrease in value because right to sell
    stock at lower prices is worth less can seller
    for higher

6
Some intuition contd.
  • In general, if a stock price falls
  • Calls will decrease in value because stock can be
    purchased for less then strike useless to buy
    higher
  • Puts will increase in value because being able to
    sell at a higher price (relative to initial) is
    desirable

7
Options A wasting asset
  • Options are considered a wasting asset because as
    they approach expiration, they lose value
  • Options have a time value, time to expiration is
    worth money can expire worthless
  • This leads professionals to favor selling
    options pros like to sell something and not buy
    it back

8
Scenarios
  • If Apple rises to 130 by March expiration
  • Then exercise option, buy 100 shares _at_ 130
  • Profits 960 ((10/share 100)- 40 Premium))
  • If Apple falls to 110 by March expiration
  • Then let option expire worthless, lose premium
  • Loss of 40 total, vs. 1000 if purchased shares
  • Why Because options allow for leverage control
    large amount of assets for small outlay

9
4 Different Option Scenarios
  • One Can buy or sell a put or call for different
    effects combined with long/short stock
  • Selling an option is also known writing

10
Buy Call
  • Generally done when outlook is bullish
  • In exchange for a premium, buyer receives the
    right to buy a stock in the future
  • Unlimited Upside, Downside limited to Premium
    Paid
  • Owner has right to call stock from seller
  • If stock rises, exercise if fall, expire
    worthless

11
Sell Call
  • Done with neutral to slightly bullish outlook
  • In exchange for premium, seller surrenders right
    to call stock
  • Effectively, seller can have stock called away
    if it rises
  • Limited Upside (Strike Price) Premium, Limited
    Downside
  • Often done when holding stock to generate
    premiums Called writing covered calls
  • If stock rises, deliver stock If stock falls,
    keep premium

12
Buy Put
  • Generally done with bearish outlook for stock
  • In exchange for premium, buyer has the right To
    put the stock to seller
  • Limited Upside, Limited Downside
  • How people hedge long stock positions
  • If stock rise, expire worthless if stock falls,
    exercise and sell stock

13
Sell Put
  • Generally done with bullish outlook
  • In exchange for premium seller surrenders right
    to put stock
  • Seller risk having stock put from buyer
  • Limited Upside, limited downside
  • If stock falls, receive stock If stock rises,
    keep premium
  • Can be used as a synthetic limit buy order
  • If stock falls below certain price (limit), stock
    is put, and one gains exposure

14
Black Scholes
  • Formula used to price options, Complicated Ito
    calculus based invented in 1970s by Fischer
    Black, Robert Merton and Myron Scholes
  • You dont need to solve it thats why we have
    Excel know what it does
  • It is not perfect but a good starting point
  • Inputs included time to expiration, current
    stock price, strike price, interest rates,
    volatility, dividends

15
Implied Volatility
  • Everyone has taken Algebra/Calculus
  • Implied Vol. is how volatile market expects
    underlying asset to be
  • Traders find by backing out of Black Scholes, by
    using market quote
  • Option Price xyzVolatility
  • Implied Vol Option Price-x-y-z
  • Many make bets on vol regardless of change in
    stock price

16
The Greeks
  • Equations measure different sensitivities of
    options, denoted by Greek letters
  • The Most important is Delta, or the sensitivity
    of an option to a 1 change in underlying
  • Technically a stock has a delta of 1 A one
    dollar change in stock price change your value 1

17
Greeks contd.
  • Calls have a positive delta
  • As stock rises, value of call increases
  • Puts have a negative delta
  • As stock rises, value of put decreases
  • Therefore, traders are able to create a delta
    neutral portfolio a portfolio that does not
    gain/lose value when stock prices fluctuate

18
Delta Neutral Example
  • Lets look at one of our holdings GS
  • Assume we own 100 shares
  • To make our GS Position delta neutral (Delta0)
  • Start with Delta of GS Equity 1
  • We need option with negative delta, so use put
  • If we take March 150 Strike, Delta-.3
  • Then, we can create a (nearly) delta neutral
    portfolio by buying 3 150 put options
  • Delta of GS Holding Equity DeltaOption Delta
  • 0 1.00 -1 (.3333)
Write a Comment
User Comments (0)
About PowerShow.com