Spotting and Valuing Options Principles of Corporate Finance Brealey and Myers Sixth Edition Slides...
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Spotting and Valuing Options Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 20 ©The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill
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Transcript of Spotting and Valuing Options Principles of Corporate Finance Brealey and Myers Sixth Edition Slides...
Spotting and Valuing Options
Principles of Corporate FinanceBrealey and Myers Sixth Edition
Slides by
Matthew Will Chapter 20
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 2
Topics Covered
Calls, Puts and Shares Financial Alchemy with Options What Determines Option Value Option Valuation
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 3
Option Terminology
Call Option
Right to buy an asset at a specified exercise price on or before the exercise date.
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 4
Option Terminology
Put Option
Right to sell an asset at a specified exercise price on or before the exercise date.
Call Option
Right to buy an asset at a specified exercise price on or before the exercise date.
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 5
Option Obligations
Buyer Seller
Call option Right to buy asset Obligation to sell asset
Put option Right to sell asset Obligation to buy asset
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 6
Option Value
The value of an option at expiration is a function of the stock price and the exercise price.
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 7
Option Value
The value of an option at expiration is a function of the stock price and the exercise price.
Example - Option values given a exercise price of $85
00051525ValuePut
25155000Value Call
110100908070$60eStock Pric
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 8
Option Value
Call option value (graphic) given a $85 exercise price.
Share Price
Cal
l opt
ion
valu
e
85 105
$20
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 9
Option Value
Put option value (graphic) given a $85 exercise price.
Share Price
Put
opt
ion
valu
e
80 85
$5
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 10
Option Value
Call option payoff (to seller) given a $85 exercise price.
Share Price
Cal
l opt
ion
$ pa
yoff
85
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 11
Option Value
Put option payoff (to seller) given a $85 exercise price.
Share Price
Put
opt
ion
$ pa
yoff
85
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 12
Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alue
Long Stock
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 13
Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alue
Long Put
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 14
Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alue Protective Put
Long Put
Long Stock
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 15
Option Value
Protective Put - Long stock and long put
Share Price
Pos
itio
n V
alue Protective Put
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 16
Option ValueStraddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alue Long call
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 17
Option ValueStraddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alue
Long put
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 18
Option ValueStraddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alue
Straddle
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 19
Option ValueStraddle - Long call and long put
- Strategy for profiting from high volatility
Share Price
Pos
itio
n V
alue
Straddle
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 20
Option Value
Upper Limit
Stock Price
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 21
Option Value
Upper Limit
Stock Price
Lower Limit
(Stock price - exercise price) or 0whichever is higher
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 22
Option Value
Components of the Option Price1 - Underlying stock price
2 - Striking or Exercise price
3 - Volatility of the stock returns (standard deviation of annual returns)
4 - Time to option expiration
5 - Time value of money (discount rate)
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 23
Option Value
Black-Scholes Option Pricing ModelBlack-Scholes Option Pricing Model
OC = Ps[N(d1)] - S[N(d2)]e-rt
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 24
OC = Ps[N(d1)] - S[N(d2)]e-rt
OC- Call Option Price
Ps - Stock Price
N(d1) - Cumulative normal density function of (d1)
S - Strike or Exercise price
N(d2) - Cumulative normal density function of (d2)
r - discount rate (90 day comm paper rate or risk free rate)
t - time to maturity of option (as % of year)
v - volatility - annualized standard deviation of daily returns
Black-Scholes Option Pricing ModelBlack-Scholes Option Pricing Model
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 25
(d1)=
ln + ( r + ) tPs
S
v2
2
v t
32 34 36 38 40
N(d1)=
Black-Scholes Option Pricing ModelBlack-Scholes Option Pricing Model
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 26
(d1)=
ln + ( r + ) tPs
S
v2
2
v t
Cumulative Normal Density FunctionCumulative Normal Density Function
(d2) = d1 - v t
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 27
Call Option
Example
What is the price of a call option given the following?
P = 36 r = 10% v = .40
S = 40 t = 90 days / 365
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 28
Call Option
(d1) =
ln + ( r + ) tPs
S
v2
2
v t
(d1) = - .3070 N(d1) = 1 - .6206 = .3794
Example
What is the price of a call option given the following?
P = 36 r = 10% v = .40
S = 40 t = 90 days / 365
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 29
Call Option
(d2) = - .5056
N(d2) = 1 - .6935 = .3065
(d2) = d1 - v t
Example
What is the price of a call option given the following?
P = 36 r = 10% v = .40
S = 40 t = 90 days / 365
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 30
Call Option
OC = Ps[N(d1)] - S[N(d2)]e-rt
OC = 36[.3794] - 40[.3065]e - (.10)(.2466)
OC = $ 1.70
Example
What is the price of a call option given the following?
P = 36 r = 10% v = .40
S = 40 t = 90 days / 365
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 31
Put - Call Parity
Put Price = Oc + S - P - Carrying Cost + Div.
Carrying cost = r x S x t
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20- 32
Example
ABC is selling at $41 a share. A six month May 40 Call is selling for $4.00. If a May $ .50 dividend is expected and r=10%, what is the put price?
Put - Call Parity
©The McGraw-Hill Companies, Inc., 2000Irwin/McGraw Hill
20- 33
Example
ABC is selling at $41 a share. A six month May 40 Call is selling for $4.00. If a May $ .50 dividend is expected and r=10%, what is the put price?
Put - Call Parity
Op = Oc + S - P - Carrying Cost + Div.
Op = 4 + 40 - 41 - (.10x 40 x .50) + .50
Op = 3 - 2 + .5
Op = $1.50
