newbie question about options

[OrangeCat]

A good overview:
http://www.investopedia.com/university/options/

Options on futures:
http://www.orionfutures.com/opts.htm#terms

Options as used for employees:
http://money.howstuffworks.com/question436.htm

If you really want to get into it, here is an online tutorial:
http://www.cboe.com/LearnCenter/Tutorials.aspx#Basics

[cwsiggy]

McMillan's books are also good

[J_V]

People that start posts like this don't want links. They want someone to explain options to them in 1-2 minutes so that they can get their options knowledge on par with their acute understanding of stocks.

I'll help him out.


An option is the right but not the obligation to buy a stock at your excercise price. If that's not right, who cares.

[Recliner]

[ QUOTE ]
People that start posts like this don't want links. They want someone to explain options to them in 1-2 minutes so that they can get their options knowledge on par with their acute understanding of stocks.

I'll help him out.


An option is the right but not the obligation to buy a stock at your excercise price. If that's not right, who cares.

[/ QUOTE ]

That's only a call, what about a put option? Which is the right to sell a stock at the strike price. If you really don't care if anything you post is correct then why bother posting?

[Rotating Rabbit]

Yes, the holder of a put option has the right to sell at the exercise price K.

You can have 'american style' options which allow you to exercise at any time up to the expiry time, and 'european style' that allow you to exercise only AT the expiry time.

An american call is worth the same as a european call provided there are no dividends to be paid.

This is not the case for a put option for all interest rates >0.

[crazy canuck]

An american call is worth the same as a european call provided there are no dividends to be paid.


This is not true. In fact under the Black Scholes framework the price of an american option (call or put) can't even be expressed analytically, i.e. there is no formula for it.

[Rotating Rabbit]

You're mistaken.

Sure, an american option cannot be expressed analytically (thats what discrete approximation models are for) but an american call is the same as a european call under geometric brownian motion, the assumption for BS. Its never preferable to exercise an american call before its expiry.

e.g. S(t) = price of security at time t. If an american call (Price C,Strike K,Expiry T) is in the money, at time t1 say, t1<T, you can exercise and realise a time-T gain of:

[S(t1)-K]e^r(T-t1)

If instead you sell short at T1, stick the funds S(t1) into a bank paying continuously compounded interest at rate r (as above), then at time T buy the stock at the minimum of K and S(T) with the bank money you have a time-T gain of:

S(t1)e^(T-t1) - min {K, S(T)}

which is greater. So its never preferable to exercise early, thus its the same expected value as its european sibling, under Black-Scholes and its assumptions.

[jason1990]

Just a point that might be of interest to some. The value of the call option when it is exercised is h(S(t)), where

h(x)=max{x-K,0}.

This function is convex and has h(0)=0. These two properties are all one needs in order to conclude that it is never optimal to exercise the option before expiry. Notice that the corresponding function for the put is still convex, but it is not 0 at 0.