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Week 4 (chapter 10): Mechanics of Option Markets (Option (Naked Option…
Week 4 (chapter 10): Mechanics of Option Markets
Option
a financial security that gives the holder
the right
to buy or sell a
specified quantity
of a
specified asset
at a
specified price
on or before a
specified date
specified date = maturity/ expire date
on or before expiration date: American
only on expiration date: European
Call option: an option to buy (an obligation to sell)
Put option: an option to sell (an obligation to buy)
Buyer/ holder/ long position
has the right
pay premiums
buy a call = long a call
Seller/ writer/ short position
has the obligation
receive premiums
sell a call = write a call = short a call
Naked Option Positions
consisting only of options of a given type (call or put)
Long call:
right
to buy
Short call:
obligation
to sell
Long put:
right
to sell
Short put:
obligation
to buy
Moneyness
At the money: exercise price = underlying price
In the money (exercise option ignore the premium)
Call: underlying price > exercise price
Put: underlying price < exercise price (strike price)
Out- of- the money (no incentive to exercise an option)
Put: underlying price > exercise price
Call: underlying price < exercise price
Properties of Stock Options
Put- Call Parity
based on the
law of one price
and the concept of
no arbitrage equilibrium
any two assets/ portfolios with the
same payoff
must sell for the
same price