47 lines
3.8 KiB
Plaintext
47 lines
3.8 KiB
Plaintext
283Chapter seventeen: A summary a nd concluding comments
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on Dow Index futures gives the buyer the right to sell one futures contract at the strike
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price. For example, a call at a strike price of 10,000 entitles the buyer to be long one futures
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contract at a price of 10,000 when he exercises the option. A put at the same strike price
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entitles the buyer to be short one futures contract at 10,000. The strike prices of Dow Index
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futures options are listed in increments of 100 index points, giving the trader the flexibility
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to express his opinions about upward or downward movement of the market.
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The seller, or writer, of a call or put is short the option. Effectively selling a call makes
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the writer short the market, just as selling a put makes the writer long the market. As in a
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futures contract, the seller is obligated to fulfill the terms of the option if the buyer exercises.
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If you are short a call, and the long exercises, you become short one futures contract at
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10,000. If you are short one put and the long exercises, you become long one futures contract
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at 10,000.
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Buyers of options enjoy fixed risk. They can lose no more than the premium they pay
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to go long an option. On the other hand, sellers of options have potentially unlimited risk.
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Catastrophic moves in the markets often bankrupt imprudent option sellers.
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Option premiums
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The purchase price of the option is called the option premium. The option premium is
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quoted in points, each point being worth $100. The premium for a Dow Index option is paid
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by the buyer at initiation of the transaction.
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The underlying instrument for one CBOT
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® futures option is one CBOT® DJIASM futures
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contract; so the option contract and the futures contract are essentially different expressions
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of the same instrument, and both are based on the Dow–Jones Index.
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Options premiums consist of two elements: intrinsic value and time value. The
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difference between the futures price and strike price is the intrinsic value of the option. If
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the futures price is greater than the strike price of a call, the call is said to be “in-the-money.”
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In fact, you can be long the futures contract at less than its current price. For example, if the
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futures price is 10,020 and the strike price is 10,000, the call is in-the-money and immediate
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exercise of the call pays $10.00 times the difference between the futures and strike price,
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or $10 × 20 = $200. If the futures price is less than the strike price, the call is “out-of-the-
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money.” If the two are equal, the call is “at-the-money.” A put is in-the-money if the futures
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price is less than the strike price and out-of-the-money if the futures price is greater than
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the strike price. It is at-the-money when these two prices are equal.
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Since a Dow Index futures option can be exercised at any date until expiration, and
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exercise results in a cash payment equal to the intrinsic value, the value of the option must
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be at least as great as its intrinsic value. The difference between the option price and the
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intrinsic value represents the time value of the option. The time value reflects the possibility
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that exercise will become more profitable if the futures price moves farther away from the
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strike price. Generally, the more time until expiration, the greater the time value of the
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option because the likelihood of the option becoming profitable to exercise is greater. At
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expiration, the time value is zero and the option price equals the intrinsic value.
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Volatility
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The degree of fluctuation in the price of the underlying futures contract is known as
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“volatility” (see Appendix B, Resources, for the formula). The greater the volatility of the
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futures, the higher the option premium. The price of a futures option is a function of the
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futures price, the strike price, the time left to expiration, the money market rate, and the volatility |