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FIN 3710 OPTIONS MARKETS NOTES

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This is a comprehensive and detailed note on Chapter 15; options market for Fin 3710. *Essential Study Material!!

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  • September 27, 2024
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Chapter 15 - Options Markets



CHAPTER 15
OPTIONS MARKETS

1. Options provide numerous opportunities to modify the risk profile of a portfolio. The
simplest example of an option strategy that increases risk is investing in an ‘all options’
portfolio of at-the-money options (as illustrated in the text). The leverage provided by
options makes this strategy very risky and potentially very profitable. An example of a
risk-reducing options strategy is a protective put strategy. Here, the investor buys a put
on an existing stock or portfolio, with exercise price of the put near or somewhat less
than the market value of the underlying asset. This strategy protects the value of the
portfolio because the minimum value of the stock-plus-put strategy is the exercise price
of the put.

2. Options at the money have the highest time premium and thus the highest potential for
gain. Since the highest potential gain is at the money, the logical conclusion is that they
will have the highest volume. A common phrase used by traders is “avoid the cheaps
and the deeps.” Cheap options are those with very little time premium. Deep options
are those that are way out of or in the money. None of these provide profit
opportunities.

3. Each contract is for 100 shares: $7.25  100 = $725

4.




5. If the stock price drops to zero, you will make $80 – $5.72 per stock, or $74.28. Given
100 units per contract, the total potential profit is $7,428.

6. The price has to be at least as much as the sum of the exercise price and the premium of
the option to breakeven: $40 + $4.50 = $45.50

7.
a. Maximum loss happens when the stock price is the same to the strike price upon
expiration. Both the call and the put expire worthless, and the investor’s outlay
for the purchase of both options is lost: $7.00 + $8.50 = $15.50



Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.

,Chapter 15 - Options Markets


b. Loss: Final value – Original investment
= (ST – X) – (C + P) = $8 – $15.50 = –$7.50

c. There are two break even prices:
i. ST > X
(ST – X) – (C + P) = (ST – 80) – $15.50 = $0  ST = $95.50
ii. ST < X
(X – ST) – (C + P) = (80 – ST) – $15.50 = $0  ST = $64.50

8. Option c is the only correct statement.
a. The value of the short position in the put is –$4 if the stock price is $76.
b. The value of the long position in the put is $4 if the stock price is $76.
d. The value of the short position in the put is zero for stock prices equaling or
exceeding $80, the exercise price.

9.
a. i. A long straddle produces gains if prices move up or down and limited losses if
prices do not move. A short straddle produces significant losses if prices move
significantly up or down. A bullish spread produces limited gains if prices
move up.

b. i. Long put positions gain when stock prices fall and produce very limited losses
if prices instead rise. Short calls also gain when stock prices fall but create
losses if prices instead rise. The other two positions will not protect the
portfolio should prices fall.

10. The initial outlay of this position is $38, the purchase price of the stock, and the payoff
of such position will be between two boundaries, $35 and $40.
a. The maximum profit will thus be: $40 – $38 = $2, and the maximum loss will
be: $35 – $38 = –$3.
b.




Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.

, Chapter 15 - Options Markets


11. The collar involves purchasing a put for $3 and selling a call for $2. The initial outlay is
$1.
a. ST = $30
Value at expiration = Value of call + Value of put + Value of stock
= $0 + ($35 – $30) + $30 = $35
Given 5,000 shares, the total net proceeds will be:
(Final Value – Original Investment)  # of shares
= ($35 – $1)  5,000 = $170,000
Net proceeds without using collar = ST  # of shares
= $30  5,000 = $150,000

b. ST = $40
Value at expiration = Value of call + Value of put + Value of stock
= 0 + 0 + $40 = $40

Given 5,000 shares, the total net proceeds will be:
(Final value – Original investment)  # of shares
= ($40 – $1)  5,000 = $195,000
Net proceeds without using collar = ST  # of shares
= $40  5,000 = $200,000

c. ST = $50
Value at expiration = Value of call + Value of put + Value of stock
= ($45 – $50) + 0 + $50 =$45

Given 5,000 shares, the total net proceeds will be:
(Final value – Original investment)  # of shares
= ($45 – $1)  5,000 = $220,000
Net proceeds without using collar = ST  # of shares
= $50  5,000 = $250,000

d. With the initial outlay of $1, the collar locks the net proceeds per share in
between the lower bound of $34 and the upper bound of $44. Given 5,000
shares, the total net proceeds will be between $170,000 and $220,000 when the
position is closed. If we simply continued to hold the shares without using the
collar, the upside potential is not limited but the downside is not protected.

12. In terms of dollar returns:



Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.

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