Chapter 14
Options Markets
Outline
Background on Options
Comparison of Options and Futures
Markets Used to Trade Options
Institutional Use of Options
How Option Trades Are Executed
Types of Orders
Stock Option Quotations
Determinants of Stock Option Premiums
Determinants of Call Option Premiums
Determinants of Put Option Premiums
How Option Pricing Can Derive a Stock’s Volatility
Explaining Changes in Stock Option Premiums
Speculating with Stock Options
Speculating with Call Options
Speculating with Put Options
Excessive Risk from Speculation
Stock Options as Compensation
Hedging with Stock Options
Hedging with Covered Call Options
Hedging with Put Options
Options on ETFs and Stock Indexes
Hedging with Stock Index Options
Dynamic Asset Allocation with Stock Index Options
Using Index Options to Measure the Market’s Risk
Options on Futures Contracts
Speculating with Options on Futures
Hedging with Options on Interest Rate Futures
Hedging with Options on Stock Index Futures
Options as Executive Compensation
Distortion between Performance and Option Compensation
Globalization of Options Markets
Currency Options Contracts
Key Concepts
1. Explain why speculators take positions in stock options and how the outcome is determined.
2. Explain why institutional investors take positions in stock options and the tradeoff involved.
3. Explain how stock index options are used by institutional investors.
4. Explain how options on financial futures are used by institutional investors.
POINT/COUNTER-POINT:
If You Were a Major Shareholder of a Publicly Traded Firm, Would You
Prefer That Stock Options Be Traded on That Stock?
POINT: No. Options can be used by investors to speculate, and excessive trading of the options may push
the stock price away from its fundamental price.
COUNTER-POINT: Yes. Options can be used by investors to temporarily hedge against adverse
movements in the stock, so they may reduce the selling pressure on the stock in some periods.
WHO IS CORRECT? Use the Internet to learn more about this issue and then formulate your own
opinion.
ANSWER: Either argument has some validity. The main point is that students recognize the interaction
between the stock price and option price. The trading of options can affect the stock price, but it may also
stabilize the trading of the underlying stock.