Tài chính doanh nghiệp - Chapter 19: Options markets

Chapter 19Options MarketsWebsite:  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonLearning ObjectivesUnderstand how call and put options are used and how they are pricedExamine the instruments traded on the Australian options marketUnderstand how options can be used for either risk management or for speculative purposesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.1 IntroductionOptions differ from futures because they provide asymmetric cover against price movementsOptions limit the effects of adverse price movements without reducing profits from favourable price movementsOptions involve a premium to be paid by the buyer to the seller (writer)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.2 The Nature of OptionsAn option gives the buyer the right, but not the obligation, to buy or sell a specified commodity or financial instrument at a predetermined price (exercise or strike price), on or before a specified date (expiration date)An option will only be exercised if it is in the buyer’s best interestCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.2 The Nature of Options (cont.)Types of optionsCall optionsGive the option buyer the right to buy the commodity or instrument at the exercise pricePut optionsGive the buyer the right to sell the commodity or instrument at the exercise priceOptions can be exercised eitherOnly on expiration date (European)Any time up to expiration date (American)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.2 The Nature of Options (cont.)Premium is the price paid by an option buyer to the writer (seller) of the option‘Cap’—an options contract that places an upper limit on an interest rate‘Floor’—an options contract that places a lower limit on an interest rate‘Collar’—a combination of cap and floor options limiting upper and lower ratesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and LossesCall option profit and loss profilesExample: a call option for shares in a listed company at a strike price of $12, and a premium of $1.50Figure 19.1 indicates the profit and loss profiles of a call option for (a) the buyer or holder (long call) and (b) the seller or writer (short call)The critical break points of the market price of the share at expiration date are $13.50If S > X (i.e. > $12) , option is ‘in-the-money’Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)The value of the option to the buyer or holder (long call party) isV = max(S - X, 0) - P (19.1)The value of the option to the writer (or short call party) isV = P - max(S - X, 0) (19.2)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Put option profit and loss profilesExample: a put option for shares in a listed company at a strike price of $12, and premium of $1.50Figure 19.2 indicates the profit and loss profiles of a put option for (a) the buyer or holder (long put) and (b) the writer or seller (short put)The critical break points of the market price of the share at expiration date are $12Buyer exercises option if S < X (i.e. < $12)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)The value of the option to the buyer or holder (long put party) isV = max(X -S, 0) - P (19.3)The value of the option to the writer (or short put party) isV = P - max(X - S, 0) (19.4)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Covered and uncovered optionsUnlike futures, the risk of loss for a buyer of an option contract is limited to the premiumHowever, sellers (writers) of options have potentially unlimited risk and may be subject to margin requirements unless they write a covered optionI.e. the writer of an option holds the underlying asset or provides a financial guaranteeCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.3 Profits and Losses (cont.)Covered and uncovered options (cont.)The writer of a call option has written a covered option if eitherThe writer owns sufficient of the underlying asset to satisfy the option contract if exercised, orThe writer is also the holder of a call option on the same asset, but with a lower exercise priceThe writer of a put option has written a covered option ifThe writer is also the holder of a put option on the same asset, but with a higher exercise priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the MarketOption markets are categorised asOver-the-counterExchange-tradedThese are recorded through a clearing houseClearing house acts as counter-party to buyer and seller, thus creating two options contracts through the process of ‘novation’The clearing house allows buyers and sellers to close out (i.e. reverse) their contractsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)International options marketsAn exchange in a particular country will usually specialise in option contracts that are directly related to physical or futures market products also traded in that particular countryTrading on international exchanges variesThe largest exchanges, CBOT and CME, retain the open outcry trading on the floor involving 4000 to 5000 peopleInternational links between exchanges allow 24-hour tradingCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options marketsTypes of options tradedOptions on futures contractsShare optionsLow exercise price options (LEPOs)WarrantsOver-the-counter marketsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Options on futures contractsTraded on the Sydney Futures Exchange (SFE)Buyer of options contract has the right to buy (call) or sell (put) a futures contractOptions on futures available for90-day bank-accepted billsS&P/ASX All Ordinaries share price index3- and 10-year Commonwealth Treasury bondsOvernight options on the above Treasury bond and share price optionsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Share optionsTraded on the ASXBased on ordinary shares of specified listed companiesUsually three or more options contracts for each company, each having identical expiration dates, but different exercise pricesThe options clearing house maintains a system of deposits, maintenance margins and a share scrip depositoryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Low exercise price options (LEPOs)Traded on the ASX since 1995A highly leveraged option on individual stocks, with an exercise price between 1 and 10 cents, and a premium that is similar to the price of the underlying stockExercisable only at expiration date (i.e. European)Available over a range of high-liquidity stocks listed on the ASXCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)WarrantsA type of option (i.e. contractual right but not obligation to buy or sell an underlying asset)Warrants may be eitherEquity warrants i.e. attached to debt issuesOption to convert debt to ordinary shares of the issuing company Financial products to manage riskIssued by financial institutionsTraded on ASX via SEATSAmerican or EuropeanCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Warrants (cont.)Other types of warrants includeFractional warrantsCover only a part of a listed shareMay require two fractional warrants to be exercised to buy a shareFully covered warrantsUnderlying shares lodged in trust by issuer as guaranteeCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Warrants (cont.)Other types of Warrants include (cont.)Index warrantsIssued on a share price index (e.g. S&P/ASX All Ordinaries index, S&P 500 indexBasket warrantsCapped warrantsInstalment warrantsCapital plus warrantsEndowment warrantsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.4 Organisation of the Market (cont.)The Australian options market (cont.)Over-the-counter marketsUsed to trade options not traded on the exchangesAllows flexibility in terms ofAmountTermInterest rate or priceCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an OptionOption price or premium is determined by four key factorsIntrinsic valueTime valuePrice volatilityInterest ratesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an Option (cont.)Intrinsic valueThe market price of the underlying asset relative to the exercise priceThe greater the intrinsic value, the greater the premiumOptions with positive intrinsic value are called ‘in-the-money’ options i.e. the buyer is able to exercise contract at a profitCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an Option (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an Option (cont.)Time value of an optionThe longer the time to expiry, the greater the possibility that the option will be able to be exercised for a profit (i.e. in-the-money)If the spot price moves adversely, the loss is limited to the premiumCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an Option (cont.)Price volatilityThe greater the volatility of the spot price, the greater the chance of exercising the option for a profit, or a lossBut the option will only be exercised if the price moves favourablyThe greater the spot price volatility, the greater the option premiumCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.5 Pricing an Option (cont.)Interest rate levelsInterest rates have opposite impacts on put and call optionsPositive relationship between interest rates and the price of a callPresent value of deferred payment if exercised versus lower present value of profit if exercisedNegative relationship between interest rates and the price of a putOpportunity cost of holding assetLower present value of the profit if exercisedCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management StrategiesSingle-option strategiesExample: long asset (i.e. bought) and bearish (negative) about future asset priceStrategyLimit downside risk by writing a call optionFigure 19.4 and Table 19.6 in the textbook illustrate the profit profile of this strategyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Single-option strategies (cont.)Example: short asset (i.e. sold) and bullish (positive) about future asset priceStrategyBuy a call in the underlying asset (i.e. take a long call position)Figure 19.5 and Table 19.7 in the textbook illustrate the profit profile of this strategyCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategiesExample: very bullish about future price of the assetStrategy: ‘vertical bull spread’—contracts with same expiration dates, different exercise pricesWrite (sell) a put option and earn a premiumTo benefit from fall in spot priceHold (buy) a call option with exercise price greater than written putEffect: Offsets high premium associated with callFigure 19.6 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Copyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: quite bullish, but with some risk of a price fallStrategyHold (buy) a call optionTo benefit from fall in spot priceWrite (sell) a call option with a higher exercise price than the long callThis ‘call bull spread’ limits the potential lossFigure 19.7 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: very bearish about the future price of the assetStrategyHold (buy) put optionTo benefit from fall in spot priceWrite (sell) a call option with a higher exercise price than the long putThis ‘vertical bear spread’ limits the potential gain but exposes the writer to unlimited lossesFigure 19.8 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: quite bearish, but with some risk of a price riseStrategyHold (buy) put optionTo benefit from fall in spot priceWrite (sell) a put option with a lower exercise price than the long putThis ‘put bear spread’ limits the potential loss if the price risesFigure 19.9 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: expectation of increased price volatility, with no trend StrategyHold (buy) a put optionHold (buy) a call option with common exercise price‘Long straddle’ provides positive pay-off for both large upward and downward price movementsIf prices remain unchanged, individual makes loss equal to sum of premiumsFigure 19.10 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: expectation of increased volatility, without trend, with stagnationStrategyHold (buy) call option with out-of-the-money exercise priceHold (buy) put option with out-of-the-money exercise priceWith ‘long strangle’ loss is decreased if price remains unchanged, compared to ‘long straddle’Figure 19.11 in textbook illustrates the profit profileCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)Example: expectation of asset price stabilityStrategyTake opposite position to long straddle and long strangleStrategy I: Short straddleSell call and put with same exercise priceStrategy II: Short strangleSell call and put, both out-of-the-moneyFigure 19.12 in textbook illustrates the profit profilesCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.6 Option Risk Management Strategies (cont.)Combined-options strategies (cont.)More complex strategiesShort butterflyShort condorCall ratio backspreadPut ratio backspreadCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.7 Conclusion: Options Versus Futures RevisitedThe potential gains and losses to buyers and sellers of futures contracts are different from that of optionsOptions provide one-sided price protection that is not available through futuresThe option buyer limits losses and allows profits to accumulateHowever, the premium may be quite highCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye WatsonChapter Organisation19.1 Introduction19.2 The Nature of Options19.3 Profits and Losses19.4 Organisation of the Market19.5 Pricing an Option19.6 Option Risk Management Strategies19.7 Conclusion: Options Versus Futures Revisited19.8 SummaryCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.8 SummaryThe holder of an option (long party) has the right to buy (call) or sell (put) the commodity at a specified exercise priceThe writer (seller) is the short partyASX and SFE trade standardised options, unlike over-the-counter marketCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson19.8 Summary (cont.)The premium paid to buy an option is affected by its intrinsic value, time value, price volatility, and interest ratesA broad array of option strategies may be adopted by hedgers and speculatorsCopyright  2003 McGraw-Hill Australia Pty Ltd PPTs t/a Financial Accounting by WillisSlides prepared by Kaye Watson