Chapter 20 – Options Markets: Introduction
20-1
CHAPTER TWENTY
OPTIONS MARKETS: INTRODUCTION
CHAPTER OVERVIEW
This chapter describes characteristics of options, terminology used in the options’ markets, payoffs and
LEARNING OBJECTIVES
After studying this chapter, the student should be able to calculate potential profits resulting from various
PRESENTATION OF MATERIAL
20.1 The Option Contract
This first section presents basic terminology used with options. Discussion of this terminology assists in
presentation of pricing and put-call parity relationships that are covered later in the chapter. The market
and exercise price relationships are presented here.
20.2 Values of Options at Expiration
Section 20.2 presents payoffs and profits for call owners (Figure 20.2) and call writers (Figure 20.3). The
call writer has unlimited loss potential if the stock price rises. The profit graphs are based on the value of
20.3 Option Strategies
A protective put involves the purchase of stock and the purchase of puts on an equivalent number of
shares. The strategy reduces upside potential if the stock price rises by the cost of the put but it limits the
Chapter 20 – Options Markets: Introduction
loss if the stock declines in price occur. It provides limited downside protection but profit potential is
20.4 The Put Call Parity Relationship
The development of the put-call parity theorem is presented here. Since the payoffs for the positions are
20.5 Option-like Securities
20.6 Financial Engineering
An example of a financially engineered product illustrates the concept in this section. The product allows
investment in index products yet behaves like a call option.
20.7 Exotic Options
One of the more innovative developments in the option market is the economic derivatives market. These
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