Introduction to Financial Derivatives
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Transcript of Introduction to Financial Derivatives
![Page 1: Introduction to Financial Derivatives](https://reader035.fdocuments.in/reader035/viewer/2022072015/56813115550346895d97684d/html5/thumbnails/1.jpg)
Introduction to Financial Derivatives
Lecture #2 on option
Jinho Bae
May 1, 2008
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Outline
1. Review
2. Margins of an option
3. Closing out an option position before expiration
4. Payoff of an option at an expiration date
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1. Review• Gim-daeri buys a put option to sell a Samsung
share for \600,000 in three months.• He pays \10,000 of premium for the option• Suppose that the price of a Samsung share is \
550,000 at the expiration date.– He exercises the option, i.e., sells the share at \0.6M.– He earns \40,000 b/c he can buy a share for \0.56M
in the spot market.
• Return of this investment– Amount invested: \10,000– Profit: \40,000
%400100000,10
000,40Return
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• Now suppose that the price of a Samsung share is \610,000 at the expiration date.– He does not exercise the option b/c he can
sell it for \610,000 in the spot market.– He earns nothing from this investment.
• Return of this investment– Amount invested: \10,000– Profit: \-10,000– Return: -10,000/10,000*100(%)=-100%
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2. Margins
• Option holder – needs to pay the option price in full when purchasing
options– has no obligation to fulfill the terms of option contracts– is not required to maintain funds in a margin account
• Option writer– may not be able to fulfill the terms of option contracts if
the option is exercised– is required to maintain a margin account
• In general, no marking to market for options, unlike futures.
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3. Closing out an option position before maturity
• An option position can be closed by issuing an offsetting order for the same option
• An example– On 5/1, Young-hee buys the right to buy a Samsung s
hare for \600,000 on 8/1 [Long call]. She pays \15,000 as a premium.
– On 5/2, she sells the right to buy a Samsung share for \600,000 on 8/1 [Short call]. She is paid \20,000 as a premium.
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Is this an offsetting order?
– On 5/1, Young-hee buys the right to buy a Samsung share for \600,000 on 8/1.
– On 5/2, she sells the right to buy a Samsung share for \610,000 on 8/1.
– The answer is
– Young-hee’s position on 5/2• One long call on Samsung with strike price of 600,000• One short call on Samsung with strike price of 610,000
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The effect of offsetting orders on open interest
① Case where the open interest goes down by one contract
– Both investors are offsetting existing positions– On 5/1, Young-hee buys the option and Chul-soo se
lls the option.– On 5/2, she sells the option and he buys the option.
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The effect of offsetting orders on open interest
② Case where the open interest stays the same– One investor is offsetting an existing position but the
other is not– On 5/1, Young-hee buys the option and Chul-soo se
lls the option.– On 5/2, she sells the option and Gil-dong buys the o
ption. Gil-dong is a new investor.
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4. Payoff of an option at expiration
• It is determined by the price of underlying asset at the expiration date
• Key features– Option holder faces an unlimited profit and a
limited loss– Option writer faces an unlimited loss and a
limited profit
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1) Long callpayoff
0
S, Price of underlying asset at maturity
-c
X
X+c
45°
• when S<X, Not exercised payoff=-c
• when S>X, exercised payoff=S-(X+c)
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2) Short callpayoff
0
c
X
X+c
45°
• when S<X, Not exercised payoff=c
• when S>X, exercised payoff=(X-S)+c
S, Price of underlying asset at maturity
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3) Long putpayoff
0
-pX-p
X
payoff=-p
payoff=(X-S)-p
S, Price of underlying asset at maturity
• when S<X,
Not exercised• when S>X,
exercised
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4) Short putpayoff
0
pX-p
X
• when S<X,
Not exercised payoff=p• when S>X,
exercised payoff=(S-X) +p
S, Price of underlying asset at maturity