Chapter 15 Options Markets Call option right to buy an asset at a specified exercise price on or before a specified expiration date Stock Price Exercise Price on Expiration date value of the call option will equal the difference between the stock price and exercise price Premium purchase price of an option represents the compensation the purchaser of the call must pay for the ability to exercise the option only when exercise is profitable Put option the right to sell an asset at a specified exercise price on or before a specified expiration date In the money an option where exercise would generate positive cash flow Out of the money option which if exercise would produce a negative cash flow Out of the money options are therefore never exercised At the money an option where the exercise price equals asset price Over the counter OTC markets advantages Terms of the option contract exercise price expiration date number of shares committed can be tailored to the need of the traders Put options are worth more when the exercise price is higher American option Can be exercised on or before its expiration European option can be exercised only at expiration Index option call or put based on a stock market index such as the S P 500 Futures options give their holders the right to buy or sell a specified future contract using as a futures price the exercise price of the option Foreign currency options currency option offers the right to buy or sell a quantity of foreign currency for a specified amount of domestic currency Interest rate options options also are traded on Treasury notes bonds T bills gov t bonds of other major economies such as the U K or Japan Call options Payoff to call holder at expiration St X if St X 0 if St X St value of the stock at expiration date X exercise price Payoff to call writer St X if St X 0 if St X Protective put asset combined with a put option that guarantees minimum proceeds equal to the puts exercise price Covered call writing a call on an asset together with buying the asset Straddle a combination of a call and a put each with the same exercise price and expiration date Spread a combination of 2 or more call options or put options on the same asset with differing exercise price or times to expiration Collar an options strategy that brackets the value of a portfolio between two bounds Chapter 16 Option Valuation Intrinsic value IV stock price minus exercise price or the cash flow that could be attained by immediate exercise of an in the money call option Time value TV difference between an option s price and its intrinsic P IV TV 6 Factors that affect the value of a call option Stock price exercise price volatility of the stock price time to expiration interest rate dividend rate of the stock Stock price increases call option increases Exercise price increases call option decreases Volatility increases call option increases Time to expiration increases call option increases Interest rate increases call option increases Dividend payouts increases call option increases Stock price increases put option decreases Exercise price increases put option increases Volatility increases put option increases Time to expiration increases put option increases uncertain Rf increases put option decreases Dividend payout increases put option increases Binomial model option valuation model predicated on the assumption that stock prices can move to only two values over any short time period Black Scholes Pricing Formula a formula to value an option that uses the stock price the risk free interest rate the time to expiration and the standard deviation of the stock return Implied volatility standard deviation of stock returns is consistent with an options market value Put call parity relationship an equation representing the proper relationship between put call prices Hedge ratios number of shares of stock required to hedge the price risk of holding one option Option elasticity percentage increase in an options value given a 1 increase in the value of the underlying security Portfolio insurance portfolio strategies that limit investment losses while maintaining upside potential Dynamic hedging constant updating of hedge positions as market conditions change Chapter 18 Portfolio Performance Evaluation Passive management holding a well diversified portfolio without attempting to search out security mispricing Cash shorthand for virtually risk free money market securities Active management attempts to achieve returns higher than commensurate with risk by forecasting broad markets and or by identifying mispriced securities Comparison universe set of portfolio managers with similar investments styles that is used to assess relative performance Shape ratio reward to volatility ratio ratio of portfolio excess return to standard deviation S R bar Standard Deviation R bar average return average risk free rate M square return difference between a managed portfolio leveraged to match the volatility of a passive index and the return on that index Fund of funds mutual funds or hedge funds that invest in other funds Treynor measure ratio of portfolio excess return to beta T R bar Beta Information ratio ratio of alpha to the standard deviation of diversifiable risk Info ratio Alpha Residual Standard Deviation Jensen measure alpha of an investment A negative or short position in a negative alpha stock will turn the alpha positive If the stocks beta is positive a negative position in it will also reduce systematic and therefore overall risk Alpha capture construction of a positive alpha portfolio with all systematic risk hedged away Alpha transfer or alpha transport establishing alpha while using index products both to hedge market exposure to establish exposure to desired sectors Survivorship bias upward bias in average fund performance due to the failure to account for failure to account for failed funds over the sample period Bogey benchmark portfolio an investment manager is compared to for performance evaluation Market timing a strategy that moves Ch 15 Self test Ch 15 Problem Sets 1 2 3 4 5 6 7 8 9 10 11 12 13 14 16 17 18 22 23 24 25 26 27 28 Self test Ch 15 CFA Problems 1 2 3 Ch 16 Self test Ch 16 Problem Sets 1 2 3 4 5 6 7 8 9 16 17 18 21 22 23 27 29 32 38 Ch 18 Self test Ch 18 Problem Sets 1 2 3 4 5 7 10 16 Ch 19 Self test Ch 19 Problem Sets 1 2 3 5 6 Self test Ch 19 CFA Problems 2 4 Ch 21 Self test Ch 21 Problem Sets 1 3 4 5 6 17 18 19 Ch 22 Self test Ch 22 Problem Sets 1 2 Self