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    Option Valuation: Bodie, Kane, and Marcus 9 Edition

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    Marwa Hassan

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    Option Valuation: Bodie, Kane, and Marcus 9 Edition

    Uploaded by

    Marwa Hassan
    138 views33 pages

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    138 views33 pages

    Option Valuation: Bodie, Kane, and Marcus 9 Edition

    Uploaded by

    Marwa Hassan

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 33

    Option Valuation

    Bodie, Kane, and Marcus


    Essentials of Investments,
    16
    9th Edition

    McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
    16.1 Introduction
    • Intrinsic Value
    • Stock price minus exercise price, or profit that
    could be attained by immediate exercise of in-
    the-money call option
    • Time Value
    • Difference between option’s price and intrinsic
    value

    16-2
    16.1 Introduction
    • Determinants of Option Value
    • Stock price
    • Exercise price
    • Volatility of price
    • Time to expiration
    • Interest rate
    • Dividend rate

    16-3
    Figure 16.1 Call Option Value before Expiration

    16-4
    Table 16.1 Determinants of Call Option Values

    16-5
    16.2 Binomial Option Pricing
    • Two-State Option Pricing
    • Assume stock price can take one of two values
    • Increase by u = 1.2, or fall by d = .9

    16-6
    16.2 Binomial Option Pricing
    • Two-State Option Pricing
    • Compare payoff to one share of stock,
    borrowing of $81.82 10% interest

    • Outlay is $18.18; payoff is three times call


    option

    16-7
    16.2 Binomial Option Pricing
    • Two-State Option Pricing
    • Portfolio of one share and three call options is
    perfectly hedged
    •

    • Hedge ratio for two-state option


    •

    16-8
    16.2 Binomial Option Pricing
    • Generalizing the Two-State Approach
    • Break up year into two intervals

    • Subdivide further using the same pattern

    16-9
    Figure 16.2A Probability Distributions for Final Stock
    Price, Three Subintervals

    16-10
    Figure 16.2B Probability Distributions for Final Stock
    Price, Six Subintervals

    16-11
    Figure 16.2C Probability Distributions for Final Stock Price,
    20 Subintervals

    16-12
    16.3 Black-Scholes Option Valuation
    • Black-Scholes Pricing Formula
    •
    • Where

    16-13
    16.3 Black-Scholes Option Valuation
    • 

    16-14
    16.3 Black-Scholes Option Valuation
    • Black-Scholes Pricing Formula
    • And where
    • r = Risk-free interest rate
    • T = Time until expiration
    • ln = Natural logarithm
    • σ = Standard deviation of annualized continuously
    compounded RoR

    16-15
    Figure 16.3 Standard Normal Probability Function

    16-16
    16.3 Black-Scholes Option Valuation
    • Black-Scholes Pricing Formula
    • Implied volatility
    • Standard deviation of stock returns consistent
    with option’s market value

    16-17
    Spreadsheet 16.1 Black-Scholes Call Option Values

    16-18
    Figure 16.4 Finding Implied Volatility

    16-19
    Figure 16.5 Implied Volatility of S&P 500

    16-20
    16.3 Black-Scholes Option Valuation
    • Put-Call Parity Relationship
    • Represents relationship between put and call
    prices
    •

    • Extension for European call options on


    dividend-paying stocks
    •

    16-21
    Figure 16.6 Payoff-Pattern of Long Call–Short Put
    Position

    16-22
    Table 16.3 Arbitrage Strategy

    16-23
    16.3 Black-Scholes Option Valuation
    • Put Option Valuation
    • Black-Sholes formula for European put option

    16-24
    16.4 Using the Black-Scholes Formula
    • Hedge Ratios and Black-Scholes Formula
    • Hedge ratio or delta
    • Number of shares required to hedge price risk
    of holding one option
    • Option elasticity
    • Percentage increase in option’s value given
    1% increase in value of underlying security

    16-25
    Figure 16.7 Call Option Value and Hedge Ratio

    16-26
    16.4 Using the Black-Scholes Formula
    • Portfolio Insurance
    • Portfolio strategies that limit investment losses
    while maintaining upside potential
    • Dynamic hedging
    • Constant updating of hedge positions as
    market conditions change

    16-27
    Figure 16.8 Profit on Protective Put Strategy

    16-28
    Figure 16.9 Hedge Ratios Change as Stock Price Fluctuates

    16-29
    16.4 Using the Black-Scholes Formula
    • Option Pricing and the Crisis of 2008-2009
    • When banks buy debt with limited liability, they
    implicitly write put option to borrower

    16-30
    Figure 16.10 Risky Loan

    16-31
    Figure 16.11 Value of Implicit Put Option on Loan
    Guarantee as % of Face Value of Debt

    16-32
    Figure 16.12 Implied Volatility as Function of Exercise
    Price

    16-33

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