INVESTMENT MANAGEMENT

Study unit 8
Options, futures
and other
derivatives
Chapters 20 and 21

Slides by
Prof J Krüger
 Learning outcomes
1. Be able to calculate potential profits resulting from
various option trading strategies.
2. Be able to formulate portfolio management strategies to
modify the risk-return attributes of the portfolio.
3. Understand the put-call parity relationship.
4. Demonstrate the ability to identify the embedded options
in various assets.
5. Demonstrate the ability to determine how embedded
option characteristics affect the prices of these assets.
6. Have an understanding of the factors affecting option
prices.
7. Be able to calculate option prices in the two-scenario
model of the economy (binomial option pricing). 2
 Learning outcomes (cont)

8. Be able to calculate the Black Scholes value of an

option.
9. Be able to calculate the hedge ratios.
10.Be able to apply delta neutral hedging.
11. Be able to construct portfolio insurance strategies using
option hedge ratios.
12.Discuss basic characteristics of futures contracts, short
and long positions and profits from such positions, and
margin trading arrangements for futures.
13.Be able to develop prices for stock index contracts.
14.Describe how contracts can be used to speculate and
hedge.
3
 Chapter Twenty Overview
 Derivatives are securities that get their value from price
of other securities
 Powerful tools for hedging and speculation
 Options traded both on organised exchanges and OTC

4
 The Option Contract: Calls
pp 659 – 665 (657 – 663; 679 – 685)

 Call option gives holder right to buy an asset

 At exercise or strike price
 On or before expiration date

 Exercise option to buy underlying asset if

market value > strike price

 If not exercised – expires and becomes valueless

5
 The Option Contract: Puts
pp 659 – 665 (657 – 663; 679 – 685)

 Put option gives its holder right to sell an asset

 At exercise or strike price
 On or before the expiration date

 Exercise option to sell underlying asset if

market value < strike price

6
 The Option Contract
pp 659 – 665 (657 – 663; 679 – 685)

 Purchase price of option called PREMIUM

 Sellers (writers) of options receive premium income

(possibility that exercise price < MV of asset)

 If holder exercises option, option writer must make (call)

or take (put) delivery of underlying asset

 Buyer NP = Value of option – premium

 Seller NP = Premium – (value of stock – exercise price)
7
Example 20.1 Profit and Loss on a Call
pp 659 – 665 (657 – 663; 679 – 685)

 A January 18, 2019 call on Microsoft with an exercise

price of $105 was selling on 2 January 2019 for $1.45

 On 2 January 2019, Microsoft sells at $101.51

 If Microsoft remains below $105, call will expire

worthless

8
Example 20.1 Profit and Loss on a Call
pp 659 – 665 (657 – 663; 679 – 685)

 Suppose Microsoft sells for $106 on the expiration date

(January 18, 2019)

 Option value = stock price – exercise price

$106 – $105= $1

 Profit = Final value – Original investment

$1.00 – $1.45 = -$0.45

 Option will be exercised to offset loss of premium

 Call will not be strictly profitable unless Microsoft price

exceeds $154.10 (strike + premium) by expiration
9
Example 20.2 Profit and Loss on a Put
pp 659 – 665 (657 – 663; 679 – 685)

 Consider a January 18 put on Microsoft with an exercise

price of $105, selling on 2 January 2019 for $4.79

 Option holder can sell a share of Microsoft for $105 at

any time until January 18

 If Microsoft goes above $105, put is worthless

10
Example 20.2 Profit and Loss on a Put
pp 659 – 665 (657 – 663; 679 – 685)

 Suppose Microsoft’s price at expiration is $101.51/$98

 Value at expiration = exercise price – stock price

$105 – $101.51 = $3.49 (not exercised)
$105 – $98 = $7 (exercised)

 Investor’s profit = Value of option – Premium

$3.49 – $4.79 = -$1.30 (not exercised)
$7 – $4.79 = $2.11 (exercised)

 Holding period return = 44.05% over 16 days! (-27.14%

over 16 days) 11
 Market and Exercise Price
Relationships pp 659 – 665 (657 – 663; 679 – 685)
In-the-money – exercise of option produces a positive
cash flow
Call: exercise price < asset price
Put: exercise price > asset price

Out-of-the-money – exercise of option would not be

profitable
Call: asset price < exercise price
Put: asset price > exercise price

At-the-money – exercise price and asset price are equal

12
 American vs. European Options
pp 662 – 665 (657 – 663; 679 – 685)

 American
 Option can be exercised at any time before expiration
or maturity
 European
 Option can only be exercised on expiration or maturity
date

 In the US, most options American style, except for

currency and stock index options

13
 Different Types of Options
pp 662 – 665 (657 – 663; 679 – 685) (SS)

 Stock Options
 Index Options
 Futures Options
 Foreign Currency Options
 Interest Rate Options

14
 Payoffs and Profits at Expiration –
Calls pp 665 – 669 (663 – 667; 685 – 689)
Notation
Stock Price = ST Exercise Price = X

Payoff to Call Holder (cannot be negative)

(ST – X) if ST >X
0 if ST < X

Profit to Call Holder

Payoff – Purchase Price

ST = $110 X = $100 Cost of call = $14

15
Figure 20.2 Payoff and Profit to Call
Option at Expiration pp 665 – 669 (663 – 667; 685 – 689)

16
 Payoffs and Profits at Expiration –
Calls pp 665 – 669 (663 – 667; 685 – 689)
Payoff to Call Writer
-(ST – X) if ST >X $100 – $110 = -$10
0 if ST < X

Profit to Call Writer

Payoff + Premium

17
Figure 20.3 Payoff and Profit to Call
Writers at Expiration pp 665 – 669 (663 – 667; 685 – 689)

18
 Payoffs and Profits at Expiration –
Puts pp 665 – 669 (663 – 667; 685 – 689)
Payoffs to Put Holder
0 if ST > X
(X – ST) if ST < X $90 < $100

Profit to Put Holder

Payoff – Premium

Assume stock price falls to $90, exercise price is $100

Then payoff = $10

19
 Payoffs and Profits at Expiration –
Puts pp 665 – 669 (663 – 667; 685 – 689)
Payoffs to Put Writer
0 if ST > X
-(X – ST) if ST < X

Profits to Put Writer

Payoff + Premium

20
Figure 20.4 Payoff and Profit to Put
Option at Expiration pp 665 – 669 (663 – 667; (685 – 689)

21
 Option versus Stock Investments
pp 665 – 669 (663 – 667; 685 – 689)

 Could a call option strategy be preferable to a direct

stock purchase?

 Suppose you think a stock, currently selling for $100, will

appreciate
 A 6-month call costs $10 (contract size is 100 shares)
 You have $10 000 to invest

22
 Option versus Stock Investments
pp 665 – 669 (663 – 667; 685 – 689)

 Portfolio A
 Invest entirely in stock
 Buy 100 shares, each selling for $100
 Portfolio B
 Invest entirely in at-the-money call options
 Buy 1 000 calls, each selling for $10
 (10 contracts, each for 100 shares)
 Portfolio C
 Purchase 100 call options for $1 000
 Invest remaining $9 000 in 6-month T-bills, to earn 3%
interest
 Bills worth $9 270 at expiration
23
 Option versus Stock Investment
pp 665 – 669 (663 – 667; 685 – 689)

Investment Strategy Investment

Equity only Buy stock @ 100 100 shares $10 000

Options only Buy calls @ 10 1 000 options $10 000

Buy calls @ 10 $ 1 000

Leveraged 100 options
Buy T-bills @ 3%
equity
yield $ 9 000

24
 Strategy Payoffs
pp 665 – 669 (663 – 667; 685 – 689)

Panel A Stock price

Portfolio $95 $100 $105 $110 $115 $120
Portfolio A: All stock $9 500 $10 000 $10 500 $11 000 $11 500 $12 000
Portfolio B: All options 0 0 5 000 10 000 15 000 20 000
Portfolio C: Call plus bills 9 270 9 270 9 770 10 270 10 770 11 270

Panel B Stock price

Portfolio $95 $100 $105 $110 $115 $120
Portfolio A: All stock -5.0% 0.0% 5.0% 10.0% 15.0% 20.0%
Portfolio B: All options -100.0 -100.0 -50.0 0.0 50.0 100.0
Portfolio C: Call plus bills -7.3% -7.3 -2.3 2.7 7.7 12.7%
25
Figure 20.5 Rate of Return to Three
Strategies pp 665 – 669 (663 – 667; 685 – 689)

26
 Strategy Conclusions
pp 665 – 669 (663 – 667; 685 – 689)

 Figure 20.5 shows that all-option portfolio, B, responds

more than proportionately to changes in stock value; it is
levered

 Portfolio C, T-bills plus calls, shows the insurance value

of options
 C’s T-bill position cannot be worth less than $9 270
 Some return potential is sacrificed to limit downside
risk

27
 Protective Put Conclusions
pp 669 – 677 (667 – 675; 689 – 698)

 Puts can be used as insurance against stock price

declines
 Protective puts lock in a minimum portfolio value
 The cost of the insurance is the put premium
 Options can be used for risk management, not just for
speculation

ST ≤ X ST > X
Stock ST ST
+ Put . X – ST 0 .
= TOTAL X ST
28
Figure 20.7 Protective put versus stock
investment (at-the-money option)
pp 669 – 677 (667 – 675; 689 – 698)

29
 Covered Calls
pp 669 – 677 (667 – 675; 689 – 698)

 Purchase stock and write calls against it

 Call writer gives up any stock value above X in return for

initial premium

 Value of covered call = stock value – value of call (write

a call that may be exercised)

 If planned to sell stock when price rises above X

anyway, call imposes “sell discipline” – guarantee that
sale will take place
30
Table 20.2 Value of a Covered Call
Position at Expiration pp 669 – 677 (667 – 675; 689 – 698)

ST ≤ X ST > X

Payoff of stock ST ST

+ Payoff of written call –0 -(ST – X)

= TOTAL ST ST

31
Figure 20.8 Value of a Covered Call
Position at Expiration pp 669 – 677 (667 – 675; 689 – 698)

32
 Straddle
pp 669 – 677 (667 – 675; 689 – 698)

 Long straddle: Buy call and put with same exercise price
and maturity

 Straddle is a bet on volatility

 To make a profit, change in stock price must exceed
cost of both options
 Need strong change in stock price in either direction

 Writer of straddle betting stock price will not change

much

33
Table 20.3 Value of a Straddle Position at
Option Expiration pp 669 – 677 (667 – 675; 689 – 698)

ST < X ST ≥ X

Payoff of call 0 ST – X

+ Payoff of put . X – ST 0 .

= TOTAL X – ST ST – X

34
Figure 20.9 Value of a Straddle at
Expiration pp 669 – 677 (667 – 675; 689 – 698)

35
 Spreads
pp 669 – 677 (667 – 675; 689 – 698)

 Spread a combination of two or more calls (or two or

more puts) on same stock with differing exercise prices
or times to maturity

 Some options bought, whereas others sold, or written

36
 Table 20.4 Value of a Bullish Spread
Position at Expiration pp 669 – 677 (667 – 675; 689 – 698)

ST ≤ X 1 X1 < S T ≤ X 2 ST ≥ X 2

Payoff of purchased call, exercise price = X1 0 ST – X 1 ST – X 1

+ Payoff of written call, exercise price = X2 . -0 -0. -(ST – X2).

= TOTAL 0 ST – X 1 X2 – X 1

37
Figure 20.10 Value of a Bullish Spread
Position at Expiration pp 669 – 677 (667 – 675; 689 – 698)

38
 Collars
pp 669 – 677 (667 – 675; 689 – 698)

 Collar – options strategy that brackets value of a

portfolio between two bounds

 Limit downside risk by selling upside potential

 Buy a protective put to limit downside risk of a position

 Fund put purchase by writing a covered call

 Net outlay for options is approximately zero

39
 Put-Call Parity
pp 677 – 680 (675 – 678; 698 – 700)

 Call-plus-bond portfolio (on left) must cost same as

stock-plus-put portfolio (on right):

X
C  S 0  P
(1  r f ) T

40
 Put-Call Parity – Disequilibrium
Example pp 677 – 680 (675 – 678; 698 – 700)
Stock Price = 110 Call Price = 17
Put Price = 5 Risk Free = 5%
Maturity = 1 yr X = 105

X
C  S0  P
(1  r f ) T

17 + 105 / (1 + 0.05)1 = 110 + 5

117 > 115

Since leveraged equity is less expensive, acquire low cost

alternative and sell high cost alternative 41
Table 20.5 Arbitrage Strategy
pp 677 – 680 (675 – 678; 698 – 700)

Cash flow in 1 Year

Position Immediate S < 105
T ST ≥ 105
cash flow
Buy stock -110 ST ST
Borrow $105 / 1.05
+100 -105 -105
= $100
-(ST – 105).
Sell call +17 0

105 – ST. 0 .
Buy put -5
TOTAL 2 0 0
42
 Option-like Securities
pp 680 – 686 (678 – 684; 701 – 707) (SS)

 Callable Bonds
 Convertible Securities
 Warrants
 Collateralised Loans

 Sections 20.6 and 20.7 – leave out

Study unit 8, Chapter 21 to follow … 43
 Chapter Twenty One Overview
 What factors affect the value of an option?
 How do you determination the price of an option?
 Binomial option pricing
 Hedge ratios
 Black-Scholes option pricing model

44
 Option Values
pp 699 – 702 (722 – 725)

 Intrinsic value – payoff that could be made if the option

was immediately exercised
 Call: stock price – exercise price
 Put: exercise price – stock price

 Time value – difference between option price and

intrinsic value, given immediate expiration

45
Figure 21.1 Call Option Value before
Expiration pp 701 – 704 (699 – 702; 722 – 725)

46
 Table 21.1 Determinants of Call Option
Values pp 701 – 704 (699 – 702; 722 – 725)
If this variable increases … The value of the call option …

Stock price, S Increases

Exercise price, X Decreases
Volatility, σ Increases
Time to expiration, T Increases
Interest rate, rf Increases
Dividend payouts Decreases

47
 Restrictions on Option Value: Call
pp 705 – 707 (703 – 705; 725 – 728)

 Call value cannot be negative

 Option payoff is zero at worst, and highly positive at
best

 Call value cannot exceed stock value

 Value of call must be greater than value of levered equity

 Lower bound = adjusted intrinsic value:

C > S0 – PV (X) – PV (D)

where (D = dividend)
48
Figure 21.2 Range of Possible Call
Option Values pp 705 – 707 (703 – 705; 725 – 728)

49
Figure 21.3 Call Option Value as a
Function of the Current Stock Price
pp 705 – 707 (703 – 705; 725 – 728)

50
 Early Exercise: Calls
pp 705 – 707 (703 – 705; 725 – 728)

 Right to exercise an American call early is valueless as

long as stock pays no dividends until option expires

 Call gains value as stock price rises – since price can

rise infinitely, call is “worth more alive than dead”

 Value of American and European calls therefore identical

51
 Early Exercise: Puts
pp 705 – 707 (703 – 705; 725 – 728)

 American puts worth more than European puts, all else

equal

 Possibility of early exercise has value because

 Value of stock cannot fall below zero
 Once firm is bankrupt, it is optimal to exercise
American put immediately because of time value of
money

52
Figure 21.4 Put Option Values as a
Function of the Current Stock Price
pp 705 – 707 (703 – 705; 725 – 728)

53
 Binomial Option Pricing: Text
Example pp 708 – 716 (706 – 714; 729 – 737)
u=1.20
d=.9

120 10

100 C

90 0
Stock Price Call Option Value
X = 110

54
 Binomial Option Pricing: Text
Example pp 708 – 716 (706 – 714; 729 – 737)
Alternative Portfolio
Buy 1 share of stock at $100 30
Borrow $81.82 (10% Rate)
Net outlay $18.18 18.18

Payoff 0
Value of Stock 90 120
Payoff Structure
Repay loan -90 -90 is exactly 3 times
Net Payoff 0 30 the Call

55
 Binomial Option Pricing: Text
Example pp 708 – 716 (706 – 714; 729 – 737)

30 30

18.18 3C

0 0

3C = $18.18
C = $6.06

56
 Replication of Payoffs and Option
Values pp 708 – 716 (706 – 714; 729 – 737)
 Alternative Portfolio
 One share of stock and 3 calls written (X = 110)

 Portfolio is perfectly hedged

Stock Value 90 120
Call Obligation 0 -30
Net payoff 90 90

Hence 100 – 3C = $81.82

or C = $6.06
57
 Hedge Ratio pp 708 – 716 (706 – 714; 729 – 737)
 In example, hedge ratio = 1 share to 3 calls or 1/3

 Generally, the hedge ratio is

range of call values Cu  C d

H 
range of stock valu es uS 0  dS 0

u up
d down

58
 Expanding to Consider Three
Intervals pp 708 – 716 (706 – 714; 729 – 737)
 Assume that we can break the year into three intervals

 For each interval stock could increase by 20% or

decrease by 10%

 Assume stock is initially selling at $100

59
 Expanding to Consider Three
Intervals pp 708 – 716 (706 – 714; 729 – 737))
Cuuu
$172.80

Cuu
Cuud
$144
Cduu
Cu $129.60
Cdu
$120
C Cud
$100 $108 Cudd
Cd Cdud
$90 $97.20
Cdd
Cddd
$81
$72.90 60
 Possible Outcomes with Three
Intervals pp 708 – 716 (706 – 714; 729 – 737)
Event Final Stock Price
3 up 100 (1.20)3 = $172.80
2 up 1 down 100 (1.20)2 (0.90) = $129.60
1 up 2 down 100 (1.20) (0.90)2 = $97.20
3 down 100 (0.90)3 = $72.90

61
Making the Valuation Model Practical
pp 708 – 716 (706 – 714; 729 – 737)

 Increasing the number of sub-periods allow for greater

refinement
 As n sub-periods increase, the probability distribution –
resembles a bell-shaped curve
 Values of u and d should be derived by σ

u = exp(σ√Δt), d = exp(-σ√Δt)

 See Figure 21.5 in your textbook – change probabilities

and see how bell curve is shaped

62
 Black-Scholes Option Valuation
pp 716 – 724 (714 – 722; 737 – 746)

Co = SoN(d1) – Xe-rTN(d2)

where
Co = Current call option value
So = Current stock price
N(d) = probability that a random draw from a normal
distribution will be less than d 63
 Black-Scholes Option Valuation
pp 716 – 724 (714 – 722; 737 – 746)

X = Exercise price
e = 2.71828, the base of the natural log
r = Risk-free interest rate (annualised, continuously
compounded with the same maturity as the
option)
T = time to maturity of the option in years
ln = Natural log function
σ = Standard deviation of the stock

64
Figure 21.6 A Standard Normal Curve
pp 716 – 724 (714 – 722; 737 – 746)

65
Example 21.4 Black-Scholes Valuation
pp 716 – 724 (714 – 722; 737 – 746)

So = 100 X = 95
r = 0.10 T = 0.25 (quarter)
σ = 0.50 (50% per year)

Thus:

( )
ln 100 95 + (0.10 + 0.5 2 / 2) 0.25
d1 = = 0.43
0.5 0.25
d 2 = 0.43 - 0.5 0.25 = 0.18

66
67
 Probabilities from Normal
Distribution pp 716 – 724 (714 – 722; 737 – 746)
Using a cumulative normal distribution table or the
NORMDIST function in Excel, we find that

N (0.43) = (0.6700 + 0.6628) / 2

= 0.6664
N (0.18) = 0.5714

Therefore
C0 = SoN(d1) – Xe-rTN(d2)
C0 = 100 X 0.6664 – 95 e- 0.10 X .25 X 0.5714
C0 = $13.70 68
 Call Option Value
pp 716 – 724 (714 – 722; 737 – 746)

Implied Volatility

 Implied volatility is volatility for stock implied by option

price

 Using Black-Scholes and actual price of option, solve for

volatility

69
Black-Scholes Model with Dividends
pp 716 – 724 (714 – 722; 737 – 746)

 Black Scholes call option formula applies to stocks that

do not pay dividends

 What if dividends ARE paid?

 One approach is to replace stock price with a dividend

adjusted stock price

Replace S0 with S0 – PV (Dividends)

70
Example 21.5 Black-Scholes Put
Valuation pp 716 – 724 (714 – 722; 737 – 746)
P = Xe-rT [1 – N(d2)] – S0 [1 – N(d1)]

Using Example 21.4 data:

S = 100, r = 0.10, X = 95, σ = 0.5, T = 0.25

We compute:
= $95e-10x.25(1 – 0.5714) – $100(1 – 0.6664)
= $6.35

71
Put Option Valuation: Using Put-Call
Parity pp 716 – 724 (714 – 722; 737 – 746)
P = C + PV (X) – So
= C + Xe-rT – So

Using the example data

P = 13.70 + 95 e -0.10 X 0.25 – 100

P = $6.35

72
 Using the Black-Scholes Formula
pp 724 – 736 (722 – 734; 746 – 758)

Hedging: Hedge ratio or delta

Number of stocks required to hedge against price risk of
holding one option
Call = N (d1)
Put = N (d1) – 1

Option Elasticity
Percentage change in option’s value given a 1%
change in value of the underlying stock

73
 Portfolio Insurance
pp 724 – 736 (722 – 734; 746 – 758)

 Buying Puts
 Results in downside protection with unlimited upside
potential

 Limitations
 Maturity of puts may be too short
 Hedge ratios or deltas change as stock values
change

74
 Option Pricing, 08 - 09 Crisis
pp 724 – 736 (722 – 734; 746 – 758) TR
 Merton’s insight into financial crisis
 When banks lend, they implicitly write a put option to
borrow
 Borrower’s ability to satisfy the loan by transferring
ownership is right to “sell” itself to the creditor
 CDS provide an even clearer example
 Figure 21.13
 When firm is strong, slope is zero, but if firm slips
implicit put rises and slope is now steeper

75
 Hedging On Mispriced Options
pp 724 – 736 (722 – 734; 746 – 758) (TR)

 Option value is positively related to volatility

 If an investor believes that volatility that is implied in
an option’s price is too low, a profitable trade is
possible
 Profit must be hedged against a decline in value of
the stock
 Performance depends on option price relative to
implied volatility

76
 Hedging and Delta
pp 724 – 736 (722 – 734; 746 – 758)
 Appropriate hedge will depend on the delta
 Delta is change in value of option relative to change in
value of stock, or slope of option pricing curve

Change in the value of the option

Delta =
Change of the value of the stock

77
Example 21.8 Speculating on Mispriced
Options pp 724 – 736 (722 – 734; 746 – 758) (TR)
Implied volatility = 33%
Investor’s estimate of true volatility = 35%
Option maturity = 60 days
Put price P = $4.495
Exercise price and stock price = $90
Risk-free rate = 4%
Delta = -0.453

78
Table 21.3 Profit on a Hedged Put
Portfolio pp 724 – 736 (722 – 734; 746 – 758) (TR)
A Cost to establish hedged position
1 000 put options @4.495/option $ 4 495
453 shares @ $90/share 40 770
Total outlay $45 265
B Value of put option as a function of the stock price at implied volatility of 35%
Stock price 89 90 91
Put price $5.254 $4.785 $4.347
Profit (loss) on each 0.759 0.290 (0.148)
C Value of and profit on hedged put portfolio
Stock price 89 90 91
Value of 1 000 put options $5 254 $4 785 $4 347
Value of 453 shares 40 317 40 770 41 223
TOTAL $45 571 $45 555 $45 570
Profit (= Value – Cost from panel A) 306 290 305
79
 Example 21.8 Conclusions
pp 724 – 736 (722 – 734; 746 – 758) (TR)

 As stock price changes, so do deltas used to calculate

hedge ratio

 Gamma = sensitivity of delta to stock price

 Gamma similar to bond convexity
 Hedge ratio will change with market conditions
 Rebalancing is necessary

80
 Delta Neutral
pp 724 – 736 (722 – 734; 746 – 758)

 When you establish a position in stocks and options that

is hedged with respect to fluctuations in the price of
underlying asset, your portfolio is said to be delta
neutral
 Portfolio does not change value when stock price
fluctuates

81
Table 21.4 Profits on Delta-Neutral
Options Portfolio pp 724 – 736 (722 – 734; 746 – 758) (TR)
A Cost flow when portfolio is established
Purchase 1 000 calls (X=90) @ $3.6202
$3 620.20 cash outflows
(option priced at implied volatility of 27%)
Write 1 589 calls (X=95) @ $2.3735
$3 771.50 cash inflow
(option prices at implied volatility of 33%)
TOTAL $ 151.30 net cash flow
B Option prices at implied volatility of 30%
Stock price 89 90 91
90-strike price calls $3 478 $3 997 $4 557
95-strike price calls 1.703 2.023 2.382
C Value of portfolio after implied volatilities converge to 30%
Stock price 89 90 91
Value of 1 000 calls held $3 478 $3 997 $4 557
– Value of 1 589 calls written 2 705 3 214 3 785
TOTAL $ 773 $ 782 $ 772
82
 Empirical Evidence on Option
Pricing pp 736 – 737 (734 – 735; 758 – 759)
 B-S model generates values fairly close to actual prices
of traded options

 Biggest concern is volatility

 Implied volatility of all options on a given stock with
same expiration date should be equal
 Empirical test show that implied volatility actually falls
as exercise price increases
 This may be due to fears of a market crash

83
 Preparation for next session
 Make sure you understand what we have covered in Chapters 20
and 21.
 Moodle quiz on Study unit 8, Chapters 20 and 21, opens on 6
October 2023 at 09:00 and closes on Thursday 19 October 2023 at
17:00
 Semester test 2 – 12 October 2023 on SUs 4 to 7
 If letter for employer required – please let me know
 No lecture on 17 August – will be available for questions in
venue from 17:30 to 18:00
 Prepare Study unit 9, Chapter 24 for your next lecture on 19
October 2023
 JSE sector report and presentation due 19 October 2023 @ 23:00 –
online submission only
 Enrolment key EBMG4022023 84