Fundamentals of
Corporate
Finance
Chapter 23
Options
Fifth Edition
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
23- 2
Topics Covered
Calls and Puts
What Determines Option Values
Spotting the Option
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Option Terminology
Call Option
Right to buy an asset at a specified exercise
price on or before the exercise date.
Put Option
Right to sell an asset at a specified exercise
price on or before the exercise date.
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Option Obligations
Buyer
Seller
Call option
Right to buy asset
Obligation to sell asset
Put option
Right to sell asset
Obligation to buy asset
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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 $180
Stock Price
$140
160
180
200
220
Call Value
0
0
0
20
40
Put Value
40
20
0
0
0
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Option Value
Call option value
Call option value (graphic) given a $180 exercise price.
$40
180
220
Share Price
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Option Value
Put option value
Put option value (graphic) given a $180 exercise price.
$40
140
180
Share Price
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Option Value
Call option $ payoff
Call option payoff (to seller) given a $180 exercise price.
180
Share Price
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Option Value
Put option $ payoff
Put option payoff (to seller) given a $180 exercise price.
180
Share Price
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Option Value
Protective Put - Long stock and long put
Position Value
Long Stock
Protective Put
Long Put
Share Price
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Option Value
Position Value
Protective Put - Long stock and long put
Protective Put
Share Price
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Option Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Position Value
Long put
Long call
Straddle
Share Price
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Option Value
Position Value
Straddle - Long call and long put
- Strategy for profiting from high volatility
Straddle
Share Price
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Option Value
Stock Price
Upper Limit
Lower Limit
(Stock price - exercise price) or 0
which ever is higher
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Option Value
Components of the Option Price
1 - 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)
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Option Value
Black-Scholes Option Pricing Model
OC = Ps[N(d1)] - S[N(d2)]e-rt
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Options on Real Assets
Real Options - Options embedded in real assets
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Options on Real Assets
Real Options - Options embedded in real assets
Option to Expand
Option to Abandon
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Options on Financial Assets
Warrants - Right to buy shares from a company at a
stipulated price before a set date.
Convertible Bond - Bond that the holder may
exchange for a specific number of shares.
Callable Bond - Bond that may be repurchased by
the issuer before maturity at specified call price.
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