corporate finance ch. 17
DESCRIPTION
Fundamentals Of Corporate Finance Standard Ed. 11TRANSCRIPT
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17-1
OPTIONS AND CORPORATE FINANCE
Chapter 17
Copyright 2014 McGraw-Hill Education. All rights rsr!d. "o rproduction or distri#ution without th prior writtn consnt o$ McGraw-Hill Education.
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KEY CONCEPTS AND SKILLS
Define option terminolog
Determine option paoff! an" profit!
De!#ri$e the ma%or "eterminant! of option pri#e!
&ra!p an" appl p't(#all parit
Determine option pri#e! '!ing the $inomial an")la#*(S#hole! mo"el!
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C+APTER O,TLINE
17-1 Option!17-. Call Option!17-/ P't Option!17-0 Selling Option!17- Option 2'ote!17-3 Com$ination! of Option!
17-7 4al'ing Option!17-5 An Option Pri#ing Form'la17-6 Sto#*! an" )on"! a! Option!
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17-1 OPTIONS
An option gie! the hol"er the right8 but not theobligation8 to $' or !ell a gien 9'antit of ana!!et on :or $efore; a gien "ate8 at pri#e!
agree" 'pon to"a- E
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OPTIONS
E'ropean er!'! Ameri#an option! E'ropean option! #an $e e
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17-'
17-. CALL OPTIONS
Call option! gie the hol"er theright8 $'t not the o$ligation8 to
buya gien 9'antit of !omea!!et on or $efore !ome timein the f't're8 at pri#e! agree"
'pon to"a-@hen e
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CALL OPTION PRICIN& AT EPIRY
At ea
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CALL OPTION PAYOFFS
20
12020 40 60 80 100
40
20
40
60
Stock price ($)
Op
tionpayoffs($)
)uy
acall
E*rcis pric + ,&0
50
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CALL OPTION PROFITS
E*rcis pric + ,&0 option pr/iu/ + ,10
)uy a call
20
12020 40 60 80 100
40
20
40
60
Stock price ($)
O
ptionpayoffs($)
50
10
10
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17-/ P,T OPTIONS
P't option! gie the hol"er theright8 $'t not the o$ligation8 to
sella gien 9'antit of ana!!et on or $efore !ome timein the f't're8 at pri#e! agree"
'pon to"a-@hen e
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P,T OPTION PRICIN& AT EPIRY
At e
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P,T OPTION PAYOFFS
20
0 20 40 60 80 100
40
20
0
40
60
Stock price ($)
O
ptionpayoffs($)
)uy a put
E*rcis pric + ,&0
50
50
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P,T OPTION PROFITS
20
20 40 60 80 100
40
20
40
60
Stock price ($)
O
ptionpayoffs($)
)uy a put
E*rcis pric + ,&0 option pr/iu/ + ,10
10
10
50
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OPTION 4AL,E
Intrin!i# 4al'e Call >a
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17-0 SELLIN& OPTIONS
The !eller :or =riter; of an option ha! anobligation-
The !eller re#eie! the option premi'm in
e
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CALL OPTION PAYOFFS
20
12020 40 60 80 100
40
20
40
60
Stock price ($)
O
ptionpayoffs($)
4llacallE*rcis pric + ,&0
50
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P,T OPTION PAYOFFS
20
0 20 40 60 80 100
40
20
0
40
50
Stock price ($)
O
ptionpayoffs($)
ll a put
E*rcis pric + ,&0
50
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OPTION DIA&RA>S RE4ISITED
E*rcis pric + ,&0
option pr/iu/ + ,10ll a call
)uy a call
50 6040 100
40
40
Stock price ($)
Optionpayoffs($)
)uy a put
ll a put
10
10
)uy a call
4llaput
)uyaput
ll a call
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17- OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5
138 130 Jan 112 19 420 9138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2
138 140 Aug 2193 6 58 7
--Put----Call--
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5
138 130 Jan 112 19 420 9
138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2
138 140 Aug 2193 6 58 7
--Put----Call--
6his option has a stri pric o$ ,1%&
a rcnt pric $or th stoc is ,1%(.2&
8uly is th *piration /onth.
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5138 130 Jan 112 19 420 9
138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2138 140 Aug 2193 6 58 7
--Put----Call--
6his /as a call option with this *rcis pric in-th-/ony #y ,%.2& + ,1%(9 : ,1%&.
uts with this *rcis pric ar out-o$-th-/ony.
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5
138 130 Jan 112 19 420 9
138 135 Jul 2365 4 2431 13/16138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2
138 140 Aug 2193 6 58 7
--Put----Call--
n this day; 2;%'& call options with this *rcis pric wr
tradd.
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5
138 130 Jan 112 19 420 9138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2
138 140 Aug 2193 6 58 7
--Put----Call--
6h CA
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5
138 130 Jan 112 19 420 9138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2
138 140 Aug 2193 6 58 7
--Put----Call--
n this day; 2;4%1 put options with this
*rcis pric wr tradd.
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OPTION 2,OTES
Option/Strike Exp. Vol. Last Vol. Last
IBM 130 Oct 364 15 107 5138 130 Jan 112 19 420 9
138 135 Jul 2365 4 2431 13/16
138 135 Aug 1231 9 94 5
138 140 Jul 1826 1 427 2138 140 Aug 2193 6 58 7
--Put----Call--
6h =6 option with a stri pric o$ ,1%& is trading $or ,.(12&.
inc th option is on 100 shars o$
stoc; #uying this option would
cost ,(1.2& plus co//issions.
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17-3 CO>)INATIONS OF OPTIONS
P't! an" #all! #an !ere a!the $'il"ing $lo#*! for more
#omple< option #ontra#t!- If o' 'n"er!tan" thi!8 o'#an $e#ome a finan#ial
engineer8 tailoring the ri!*(ret'rn profile to meet o'r#lient! nee"!-
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PROTECTI4E P,T STRATE&Y:PAYOFFS;
)uy a put with an *rcis
pric o$ ,&0
)uy th
stoc
rotcti! ut payo$$s
,&0
,0
,&0
3alu at*piry
3alu o$
stoc at
*piry
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PROTECTI4E P,T STRATE&Y:PROFITS;
)uy a put with *rcis pric o$ ,&0
$or ,10
)uy th stoc at ,40
,40
rotcti! ut
stratgy has
downsid protction
and upsid potntial
,40
,0
-,40
,&0
3alu at*piry
3alu o$
stoc at
*piry
-,10
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CO4ERED CALL STRATE&Y
ll a call with *rcis prico$ ,&0 $or ,10
)uy th stoc at ,40
,40
Co!rd Call stratgy
,0
-,40
,&0
3alu at
*piry
3alu o$ stoc at *piry
-,%0
,10
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LON& STRADDLE
30 40 60 70
30
40
Stock price ($)
Optionpayoffs
($)
)uy a put with *rcis
pric o$ ,&0 $or ,10
)uy a call with *rcis
pric o$ ,&0 $or ,10
A
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S+ORT STRADDLE
30
30 40 60 70
40
Stock price ($)
Opt
ionpayoffs($)
,&0
6his hort traddl only loss /ony i$ th stoc
pric /o!s ,20 away $ro/ ,&0.
ll a put with *rcis pric o$
,&0 $or ,10
ll a call with an
*rcis pric o$ ,&0 $or ,10
20
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P,T(CALL PARITY PGJ SG CGJ E:1J R;T
#ond
25
25
Stock price ($)
Option
payoffs($)
Considr th payo$$s $ro/ holding a port$olio
consisting o$ a call with a stri pric o$ ,2& and a
#ond with a $utur !alu o$ ,2&.
Call
ort$olio payo$$ort$olio !alu today + C05
>15R?T
E
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17-%%
P,T(CALL PARITY
25
25
Stock price ($)
Optionpayoffs($)
Considr th payo$$s $ro/ holding a port$olio consisting
o$ a shar o$ stoc and a put with a ,2& stri.
ort$olio !alu today +P05 S0
ort$olio payo$$
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P,T(CALL PARITY
inc ths port$olios ha! idntical payo$$s; thy /ust ha!
th sa/ !alu today@ hnc
ut-Call arity@ C05E>15R?T+P05 S0
2&
2&
toc pric >,?
0ptionpay
o$$s>,?
2&
2&
toc pric >,?
0ptionpay
o$$s>,? ort$olio !alu today
+P05 S0
ort$olio !alu today
>15R?T
E
+ C05
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17-7 4AL,IN& OPTIONS
The la!t !e#tion#on#erne" it!elf
=ith the al'eof an option ate
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A>ERICAN CALL
C0/ust $all within /a* >S0:E,0? B C0 B S0.
25
Option
payoffs($) Call
S6
loss
E
ro$it
ST
pculati! !alu
ntrinsic !alu
Mart 3alu
n-th-/onyut-o$-th-/ony
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OPTION 4AL,E DETER>INANTS
Call ut1. toc pric 5 :
2. E*rcis pric : 5
%. ntrst rat 5 :
4. 3olatility in th stoc pric 5 5
&. E*piration dat 5 5
6h !alu o$ a call option C0/ust $all within/a* >S0:E,0? B C0 B S0.
6h prcis position will dpnd on ths $actors.
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17-5 AN OPTION PRICIN& FOR>,LA
@e =ill !tart=ith a $inomial
option pri#ingform'la to$'il" o'r
int'ition-
Then =e =illgra"'ate to
the normalappro
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)INO>IAL OPTION PRICIN& >ODEL
S'ppo!e a !to#* i! =orth . to"a an" in one perio" =ill
either $e =orth 1M more or 1M le!!- SG . to"a an" inone ear S1i! either .5-7 or .1-.- The ri!*(free rate i!M- @hat i! the al'e of an at(the(mone #all option
,2&
,21.2& + ,2&>1 :.1&?
,2(.7& + ,2&>1.1&?S1S0
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17-40
)INO>IAL OPTION PRICIN& >ODEL
1- A #all option on thi! !to#* =ith e
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)INO>IAL OPTION PRICIN& >ODEL
)orro= the pre!ent al'e of .1-. to"a an" $' 1!hare-
The net paoff for thi! leere" e9'it portfolio in oneperio" i! either 7-G or G-
The leere" e9'it portfolio ha! t=i#e the option!paoff8 !o the portfolio i! =orth t=i#e the #all optional'e-
,2&
,21.2&
,2(.7&
S1S0
d#t
:,21.2&
port$olio
,7.&0
,0
> : ? +
+
+
C1
,%.7&
,0: ,21.2&
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)INO>IAL OPTION PRICIN& >ODEL
The al'e to"a of the leere"e9'it portfolio i! to"a! al'eof one !hare le!! the pre!ental'e of a .1-. "e$t
,2&
,21.2&
,2(.7&
S1
S0
d#t:,21.2&
port$olio,7.&0
,0
> : ? +
+
+
C1
,%.7&
,0: ,21.2&
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)INO>IAL OPTION PRICIN& >ODEL
@e #an al'e the #all option
to"a a! half of the al'e ofthe leere" e9'it portfolio
,2&
,21.2&
,2(.7&
S1S0 d#t
:,21.2&
port$olio
,7.&0
,0
> : ? +
+
+
C1,%.7&
,0: ,21.2&
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)INO>IAL OPTION PRICIN& >ODEL
If the intere!t rate i! M8 the #all i! =orth.,2&
,21.2&
,2(.7&S1S0 d#t
:,21.2&port$olio,7.&0
,0
> : ? ++
+
C1,%.7&
,0: ,21.2&
,2.%(
C0
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)INO>IAL OPTION PRICIN& >ODEL
the repli#ating portfolio int'ition-
Many dri!ati! scuritis can # !alud #y
!aluing port$olios o$ pri/iti! scuritis
whn thos port$olios ha! th sa/ payo$$s
as th dri!ati! scuritis.
6h /ost i/portant lsson >so $ar? $ro/ th#ino/ial option pricing /odl is@
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DELTA
Thi! pra#ti#e of the #on!tr'#tion of ari!*le!! he"ge i! #alle" delta hedging-
The "elta of a #all option i! po!itie- Re#all from the e
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DELTA
Determining the amo'nt of$orro=ing
4al'e of a #all Sto#* pri#e Delta
Amo'nt $orro=e"
.
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T+E RISK(NE,TRAL APPROAC+
@e #o'l" al'e the option8 V:G;8 a! the al'e of therepli#ating portfolio- An e9'ialent metho" i! risk-neutral valuation:
S>0?; V>0?
S>U?; V>U?
S>D?; V>D?
q
1- q
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T+E RISK(NE,TRAL APPROAC+
S:G; i! the al'e of the 'n"erling a!!et to"a-
S>0?; V>0?
S>U?; V>U?
S>D?; V>D?
S>U? and S>D? ar th !alus o$ th asst in th n*t priod$ollowing an up /o! and a down /o!; rspcti!ly.
V>U? and V>D? ar th !alus o$ th option in th n*t priod$ollowing an up /o! and a down /o!; rspcti!ly.
q
1- q
qis th ris-nutral
pro#a#ility o$ an
upF /o!.
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17-&0
T+E RISK(NE,TRAL APPROAC+
The *e to fin"ing qi! to note that it i! alrea" impo'n"e"into an o$!era$le !e#'rit pri#e the al'e of S:G;
S>0?; V>0?
S>U?; V>U?
S>D?; V>D?
q
1- q
A /inor #it o$ alg#ra yilds@
EA>PLE OF RISK NE,TRAL
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EA>PLE OF RISK(NE,TRAL4AL,ATION
S'ppo!e a !to#* i! =orth . to"a an" in one perio"=ill either $e =orth 1M more or 1M le!!- The ri!*(free rate i! M- @hat i! the al'e of an at(the(mone#all optionThe $inomial tree =o'l" loo* li*e thi!
$21.25;C>D?
q
1- q
$25;C>0?
$28.75;C>U?
EA>PLE OF RISK NE,TRAL
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EA>PLE OF RISK(NE,TRAL4AL,ATION
The ne
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EA>PLE OF RISK(NE,TRAL4AL,ATION
After that8 fin" the al'e of the #all in the 'p!tate an" "o=n !tate-
$21.25; $0
2/3
1/3
$25;C>0?
$28.75; $3.75
EA>PLE OF RISK(NE,TRAL
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17-&4
EA>PLE OF RISK(NE,TRAL4AL,ATION
Finall8 fin" the al'e of the #all at time G
$21.25; ,0
2/3
1/3
$25;C>0?
$28.75;,%.7&
$25;$2.38
RISK NE,TRAL 4AL,ATION AND
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RISK(NE,TRAL 4AL,ATION ANDT+E REPLICATIN& PORTFOLIO
Thi! ri!*(ne'tral re!'lt i! #on!i!tent =ithal'ing the #all '!ing a repli#ating portfolio-.
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T+E )LACK(SC+OLES >ODEL
Ihr
C0+ th !alu o$ a Europan option at ti/ t+ 0
R+ th ris-$r intrst rat.
">d? + ro#a#ility that astandardiJd; nor/ally
distri#utd; rando/
!aria#l will # lss than
or Kual to d.
6h )lac-chols Modl allows us to !alu options in th
ral world Lust as w ha! don in th 2-stat world.
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T+E )LACK(SC+OLES >ODEL
Fin" the al'e of a !i
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T+E )LACK(SC+OLES >ODEL
Let! tr o'r han" at '!ing the mo"el- If o' hae a#al#'lator han"8 follo= along-
6hn;
irst calculat d1
and d2
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17-&
T+E )LACK(SC+OLES >ODEL
">d1? + ">0.&2(1&? + 0.701%
">d2? + ">0.%1'02? + 0.'2401.
17 6 STOCKS AND )ONDS AS
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17-'0
17-6 STOCKS AND )ONDS ASOPTIONS
Leere" e9'it i! a #all option- The 'n"erling a!!et #ompri!e! the a!!et! of the
firm- The !tri*e pri#e i! the paoff of the $on"-
If at the mat'rit of their "e$t8 the a!!et! ofthe firm are greater in al'e than the "e$t8 the!harehol"er! hae an in(the(mone #all- The=ill pa the $on"hol"er! an" #all inB the a!!et!of the firm-
If at the mat'rit of the "e$t the !harehol"er!hae an o't(of(the(mone #all8 the =ill notpa the $on"hol"er! :i.e.,the !harehol"er! =ill"e#lare $an*r'pt#; an" let the #all e
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STOCKS AND )ONDS AS OPTIONS
Leere" e9'it i! a p't option- The 'n"erling a!!et #ompri!e! the a!!et! of thefirm-
The !tri*e pri#e i! the paoff of the $on"-
If at the mat'rit of their "e$t8 the a!!et!
of the firm are le!! in al'e than the "e$t8!harehol"er! hae an in(the(mone p't-
The =ill p't the firm to the $on"hol"er!-
If at the mat'rit of the "e$t the
!harehol"er! hae an o't(of(the(monep't8 the =ill not e
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17-'2
STOCKS AND )ONDS AS OPTIONS
It all #ome! "o=n to p't(#all parit-
3alu o$ a
call on th$ir/
3alu o$ a
put on th$ir/
3alu o$ a
ris-$r#ond
3alu o$
th $ir/+ 5 :
tocholdrNsposition in tr/s
o$ call options
tocholdrNsposition in tr/s
o$ put options
C0 + S0 5 0: >15R?TE
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2,ICK 2,I
@hat i! the "ifferen#e $et=een #allan" p't option!
@hat are the ma%or "eterminant! of
option pri#e! @hat i! p't(#all parit @hat =o'l"
happen if it "oe!nt hol" @hat i! the )la#*(S#hole! option
pri#ing mo"el