Options

• Option overview

• Option quotes

• Calculation of returns – an example

• Payoffs from long and short positions

• Put-call parity

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Call Derivative Security Put

Writer Underlying Asset

Hedge Ratio Option Bounds Hedged Portfolio

Risk-free Rate
Expiration
OPTIONS

American Intrinsic Value European

Volatility Premium

Leverage Exercise/Strike Price In/At/Out-of-the-money

“Terms highlighted in red are not required material in COMM 308.”

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Option Quotes

BCE Inc. Stock Close 26.74

Strike Expiry Option Bid Ask Last Volume OpInt

24.00 May Call 2.65 2.80 2.60 50 100
26.00 May Call 0.70 0.80 0.70 170 225
28.00 May Put 1.20 1.35 1.40 124 7254
30.00 May Put 3.20 3.35 3.30 84 479
26.00 June Call 0.90 1.00 1.00 60 145
28.00 June Put 1.55 1.65 1.75 15 410
22.00 Aug Call 4.70 4.80 4.60 10 10
26.00 Aug Call 1.20 1.35 1.20 34 388
26.00 Aug Put 0.60 0.75 0.70 15 410
30.00 Aug Call 0.05 0.15 0.10 31 2996
26.00 Nov Call 1.50 1.70 1.65 52 110
26.00 Nov Put 1.05 1.20 1.10 38 161
28.00 Nov Call 0.60 0.75 0.60 5 578
28.00 Nov Put 2.20 2.35 2.20 50 297
30.00 Nov Call 0.20 0.30 0.20 10 352
30.00 Nov Put 3.75 3.90 3.80 43 249

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 Put Options and the Market Crash of 1987

Speculators who were fortunate enough to hold put options when the marked crashed
fared quite well. On Thursday, October 15, 1987, the Dow Jones Industrials index dropped
over 90 points (it was trading at around 2,000 at the time). The next day, the market index fell
by more than 100 points. On Monday, October 19, 1987, the Dow took a freefall of some 508
points!
The following calculations show the profits available to a speculator who held a put
option on the S&P 100 on October 13 and sold it at the end of the day on October 19.

Tuesday October 13 Monday October 19

S&P100 Index 307.36 216.31

S&P100 Nov 305 put 7 1/8 118

Option profit = (118 – 7 1/8)  100 = $11,087.50

Return on option = ($11,087.50/$712.50) = 1,556% for 1 week. The annualized return is

approximately 81,000%!

By comparison: Return on shorting the index = (307.36 – 216.31)/307.36 = 29.6%

Reason for the difference?

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 Value of a Call at Expiration

O ption Value
Upper bound
Long Call
Lower bound
Intrinsic value

In -the -money

Out -of -the -money Stock Price

Exercise
Price
Short Call

Profits/Losses from a Call at Expiration

Profit

Short Call

Exercise Stock Price

Price

Long Call

Loss
5
 Factors That Influence Option Prices

1. Current price of the underlying stock

2. Strike price
3. Time to expiration of the option
4. Expected price volatility of the stock over option’s life
5. Short-term risk-free rate over the life of the option
6. Dividends on underlying stock over the life of the option

Comparative Statics

Factor Call Put

S + -
X - +
T + +
σ + +
RF + -
D - +

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 Put-Call Parity

For European options on non-dividend paying stocks it is possible to form two portfolios that
have equivalent value under all possible states and therefore can be considered as being
equal. We can therefore write:

Price of a stock + Price of a put = Price of a call + PV(X)

Using our notation:

S0 + p = c + PV(X)

This relationship is referred to as put-call parity

Assuming discrete compounding, we can write

S0 + p = c + X/(1+RF)T

With continuous compounding, this same relationship is:

S0 + p = c + Xe-RF×T Not important for COMM 308

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Example: The price of a non-dividend paying stock is $19 and the price of a three-month
European call option on the stock with a strike price of $20 is $1. The risk-free rate is 4% per
annum. What is the price of a three-month European put option with a strike price of $20?

Solution: c = 1, T = 0.25, S0 = 19, X = 20 and RF= 0.04.

Solving for p we get: p = 1 + 20/(1 + 0.04)0.25 – 19 = 1.8049

Extra Problem – Options

1. Use the option quote below to answer the following questions:

Calls - Last
Option & Strike
TSX Close Price Jan Feb Mar
Canada Corp.
50 40 8 11.50 14

a. Are the call options in-the-money? What is the intrinsic value of a Canada Corp. call
option?
b. One of the options is clearly mispriced. Which one? At a minimum, what should
it sell for? Explain how you could profit from the mispricing.
c. What is the highest price the mispriced option should sell for?