FIN 501 Lecture 14: FIN 501 Chap 14 - Options.docx

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crimsonalpaca842

20 Nov 2014

School

Ryerson University

Department

Finance

Course

FIN 501

Professor

Lianzeng(edward) Yuan

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Document Summary

Derivative security value of option is derived from value of underlying common stock. Call option givers holder right to buy 100 shares of stock at strike price. Put option gives holder right to sell 100 shares of stock at strike price. American option exercised any time before expiry. European option exercised only on last day before expiration. Option chain list of available option + their prices for particular security arrayed by strike price + maturity. Options clearing corporation (occ) + canadian derivatives clearing corporation (cdcc) o. Agencies that guarantee terms of option will be fulfilled if option is exercised. Stock index options option on a stock market index. Cash settlement procedure shorter pays longer intrinsic value of option. Intrinsic value payoff that option holder receives if underlying stock price does not change from its current value. Option time value difference between option price + intrinsic value. In the money yield positive payoff if exercised.

Related Questions

A call option gives the holder (Points : 4) the obligation to buy something the right to sell something the right to buy something the obligation to sell something none of the above Question 2. 2. A call option priced at $2 with a stock price of $30 and an exercise price of $35 allows the holder to buy the stock at (Points : 4) $2 $32 $33 $45 $35 Question 3. 3. A put option in which the stock price is $60 and the exercise price is $65 is said to be (Points : 4) in-the-money out-of-the-money at-the-money exercisable none of the above Question 4. 4. Organized options markets are different from over-the-counter options markets for all of the following reasons except (Points : 4) exercise terms physical trading floor regulation standardized contracts credit risk Question 5. 5. The advantages of the over-the-counter options market include all of the following except (Points : 4) customized contracts privately executed freedom from government regulation lower prices none of the above Question 6. 6. The option price is also referred to as the (Points : 4) strike spread premium fee none of the above Question 7. 7. An investor who exercises a call option on an index must (Points : 4) accept the cash difference between the index and the exercise price purchase all of the stocks in the index in their appropriate proportions from the writer immediately buy a put option to offset the call option immediately write another call option to offset none of the above Question 8. 8. What amount must a call writer pay if a cash-settled index call is exercised? (Points : 4) difference between the index level and the exercise price exercise price difference between the exercise price and the index level index level none of the above Question 9. 9. You are the purchaser of a call option with $5 premium and $145 exercise price. You bought this option when the stock price was $120. If the stock price now is $155, what is the net cash flow to you if you exercise? (Points : 4) $10 $5 $30 $35 Question 10. 10. You are the purchaser of a put option where the premium is $4 and exercise price is $52. You bought this option when the stock price was $52. If the stock price is $42 right now, what is your net cash flow? (Points : 4) negative $14 negative $6 $6 $4 Question 11. 11. You wrote a call option with premium of $5 and exercise price of $55. You sold this when the stock price was $45. If the stock price now is $65, what is your net cash flow? (Points : 4) negative $5 $25 $20 $5 negative $10 Question 12. 12. You wrote a put option with a premium of $3 and exercise price of $22. You sold this option when the stock price was $25. If the stock price is $22 now, what is your net cash flow? (Points : 4) $6 $3 negative $3 $0 negative $6 Question 13. 13. The maximum gain of the writer of a put option with a premium of $3 and an exercise price of $120 is: (Points : 4) $120 $117 $3 $123 unlimited Question 14. 14. The maximum gain of the purchaser of a put option with a premium of $3 and exercise price of $120 would be: (Points : 4) unlimited $120 $117 $3 $123 Question 15. 15. The maximum gain of the writer of a call option with a premium of $3 and an exercise price of $120 would be (Points : 4) unlimited $3 $117 $120 $123 Question 16. 16. The maximum gain of the purchaser of a call option with a premium of $3 and an exercise price of $120 would be (Points : 4) unlimited $120 $117 $123 $3 Question 17. 17. You have the following information: Put: X=$40, Premium=$4 Call: X=$50, Premium=$6 You bought the stock at $45 Scenarios: S=20, S=45, S=90 Given above information, please calculate the net payouts for a protective put strategy for each different scenario. (Points : 4) -$9, -$4, $41 $25, $0, $0 -$5, $-9, $0 $16, -$4, $45 Question 18. 18. You have the following information: Put: X=$40, Premium=$4 Call: X=$50, Premium=$6 You bought the stock at $45 Scenarios: S=20, S=45, S=90 Given above information, please calculate the net payouts for a covered call strategy for each different scenario. (Points : 4) $6, $6, $11 $6, $0, $51 -$19, $6, $11 -$19, $6, $51 -$6, -$6,$45 Question 19. 19. You have the following information: Put: X=$40, Premium=$4 Call: X=$50, Premium=$6 You bought the stock at $45 Scenarios: S=20, S=45, S=90 Given above information, please calculate the net payouts for a collar strategy for each different scenario. (Points : 4) -$3, $2, $7 -$9, $6, $11 $16, $2, $52 -$4, $0, $6 Question 20. 20. You have the following information: S=65, X=60, T=1, r=0, C=7, P=4 Evaluating the situation from a Put-Call Parity framework, what steps would you take to implement an arbitrage strategy? (Points : 4) Sell Call, Buy Put, Short Stock, Invest remainder Sell Call, Buy Put, Buy Stock, Borrow remainder Buy Call, Sell Put, Buy Stock, Borrow remainder Buy Call, Sell Put, Short Stock, Invest remainder Buy Call, Sell Put, Short Stock, Borrow remainder Question 21. 21. Given the information and the solution you found for Question #20, what is the arbitrage amount? (Points : 4) If S>X, then $6 and if SX, the arbitrage will be $4 If S>X, then $3 and if SX, then $2 and if SX, the arbitrage will be $2 Question 22. 22. You have the following information: S=26, X=20, T=2, r=3.4%, C=15, P=6 Evaluating the situation from a Put-Call Parity framework, what steps would you take to implement an arbitrage strategy? (Points : 4) Sell Call, Buy Put, Buy Stock, Borrow remainder Sell Call, Buy Put, Short Stock, Invest reaminder Buy Call, Sell Put, Buy Stock, Borrow remainder Buy Call, Sell Put, Buy Stock, Invest remainder Buy Call, Sell Put, Short Stock, Invest remainder Question 23. 23. Using the information and the solution from Question #22, what would be the final arbitrage amount? (approximately) (Points : 4) If S>X or SX then $9, if SX or SX then $3, if SX or S

orchidporcupine923

As a newly minted MBA. you've taken a management position with Exotic Cuisines, Inc., a restaurant chain that just went public last year. The company's restaurants specialize in exotic main dishes, using ingredients such as alligator, buffalo, and ostrich. A concern you had going in was that the restaurant business is very risky. However, after some due diligence, you discovered a common misperception about the restaurant industry. It is widely thought that 90 percent of new restaurants close within three years; however, recent evidence suggests the failure rate is closer to 60 percent over three years. So, it is a risky business, although not as risky as you originally thought. During your interview process, one of the benefits mentioned was employee stock options. Upon signing your employment contract, you received options with a strike price of $50 for 10,000 shares of company stock. As is fairly common, your stock options have a three-year vesting period and a 10-year expiration, meaning that you cannot exercise the options for a period of three years, and you lose them if you leave before they vest. After the three-year vesting period, you can exercise the options at any time. Thus, the employee stock options are European (and subject to forfeit) for the first three years and American afterward. Of course, you cannot sell the options, nor can you enter into any sort of hedging agreement. If you leave the company after the options vest, you must exercise within 90 days or forfeit. Exotic Cuisines stock is currently trading at $26.12 per share, a slight increase from the initial offering price last year. There are no market traded options on the company's stock. Because the company has only been traded for about a year, you are reluctant to use the historical returns to estimate the standard deviation of the stock's return. However, you have estimated that the average annual standard deviation for restaurant company stocks is about 55 percent. Since Exotic Cuisines is a newer restaurant chain, you decide to use a 65 percent standard deviation in your calculations. The company is relatively young, and you expect that all earnings will be reinvested back into the company for the near future. Therefore, you expect no dividends will be paid for at least the next 10 years. A three-year Treasury note currently has a yield of 1.5 percent, and a 10-year Treasury note has a yield of 2.6 percent.

4. Why do you suppose employee stock options usually have a vesting provision? Why must they be exercised shortly after you depart the company even after they vest?

5. A controversial practice with employee stock options is repricing. What happens is that a company experiences a stock price decrease, which leaves employee stock options far out of the money or "underwater." In such cases, many companies have "repriced" or "restruck" the options, meaning that the company leaves the original terms of the option intact, but lowers the strike price. Proponents of repricing argue that since the option is very unlikely to end in the money because of the stock price decline, the motivational force is lost. Opponents argue that repricing is in essence a reward for failure. How do you evaluate this argument? How does the possibility of repricing affect the value of an employee stock option at the time it is granted?

6. As we have seen, much of the volatility in a company's stock price is due to systematic or marketwide risks. Such risks are beyond the control of a company and its employees. What are the implications for employee stock options? In light of your answer, can you recommend an improvement over traditional employee stock options?

periwinklesea-lion981

Students will construct a well-diversified portfolio using an initial investment stake of $50,000 (the portfolio should use at least 95% of the initial investment, but they may not use more than $50,000). Students may include stocks, common or preferred; bonds, corporate or U.S. Treasury bonds; mutual funds, and futures contracts, or options. Students will use the closing prices from the first day of the class to determine the price of each issue. Only whole lots of any issues may be acquired; that is, no less than 100 shares of common or preferred stock, no less than five corporate bonds or $10,000 for U.S. Treasury Bonds, no fewer than the minimum required investment for any mutual fund, and no fewer than five contracts for any option or futures position. The settlement date will be the first day of Week Three. Students do not have to use all of the above mentioned securities, but they must use more than one class of security. Transaction costs are ignored in the creation of the portfolio.

The Final Project is to be written in accordance with APA guidelines as outlined in the Ashford Writing Center.

Explains their investment strategy, including an assessment of their willingness to bear risk.
Describes the securities in the portfolio, including a description of the historical information for each firm.
Calculates a quarterly and annualized return on the portfolio, and the expected return for the portfolio (students may use the closing prices as of December 31st of last year).
Computes the beta of the portfolio (MERGENT, in the Ashford Online Library, can be used to find the historical betas of each security) using concepts learned within the course.
Summarizes the risks of their portfolio and determines any areas where they might consider reinvesting portions of their portfolio to achieve either less risk or higher expected return.

The Final Project:

Must be eight to ten double-spaced pages in length (not including title and reference pages), and formatted according to APA style
Must include a title page with the following:
a. Title of paper
b. Student

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FIN 501 Lecture 14: FIN 501 Chap 14 - Options.docx

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