Chapter 12: Options Contracts

Last updated
Save as PDF

Page ID: 79444

\( \newcommand{\vecs}[1]{\overset { \scriptstyle \rightharpoonup} {\mathbf{#1}} } \) \( \newcommand{\vecd}[1]{\overset{-\!-\!\rightharpoonup}{\vphantom{a}\smash {#1}}} \)\(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\) \(\newcommand{\id}{\mathrm{id}}\) \( \newcommand{\Span}{\mathrm{span}}\) \( \newcommand{\kernel}{\mathrm{null}\,}\) \( \newcommand{\range}{\mathrm{range}\,}\) \( \newcommand{\RealPart}{\mathrm{Re}}\) \( \newcommand{\ImaginaryPart}{\mathrm{Im}}\) \( \newcommand{\Argument}{\mathrm{Arg}}\) \( \newcommand{\norm}[1]{\| #1 \|}\) \( \newcommand{\inner}[2]{\langle #1, #2 \rangle}\) \( \newcommand{\Span}{\mathrm{span}}\)\(\newcommand{\AA}{\unicode[.8,0]{x212B}}\)

At a very exclusive party, a high-class, finely clad woman slinked up to the CEO of a Fortune 500 company and said, “I will do anything – anything you want.” The CEO flatly responded, “Reprice my options.” ‒ Attributed to Warren Buffett

Learning Objectives

In this chapter, you will

Be introduced to the concepts and basics of options contracts
Explore the rationale behind the use the options contracts
Examine call and put options contracts
Discuss the difference between the options contracts buyer and the options contracts seller (aka writer, maker)
Explore the various characteristics of options contracts such as strike price, expiration date, exercise style, break-even price, and time value
Examine various options contracts strategies including straddles and spreads
Explore Employee Stock Options (ESOs), the valuation of options contracts, other types of options contracts, and warrants

By the end of this chapter, you should be able to

Describe the rationale and use of options contracts
Explain the differences between call options and put option
Identify the various characteristics of options contracts
Describe the differences between the options contract buyer and the options contract seller (aka writer, maker)
Explain various option contracts strategies
Determine whether an option contract is “in-the-money,” “at-the-money,” or “out-of-the-money”
Calculate the breakeven price for call and put options
Calculate the profit or loss from various scenarios of purchasing and exercising options contracts
Describe Employee Stock Options (ESOs) and warrants

We now embark upon a very unusual part of our journey. In the next several modules, we will explore various instruments that the vast majority of us should stay far, far away from. “That's a bit odd,” you say? "Why are we learning about products that we should stay far, far away from?" The reason we are learning about options is that we can protect ourselves, our family members, our friends, and our colleagues from them. Instruction about syphilis is not an instruction to get syphilis! And the same is true of options, futures, buying on margin, shorting, etc. However, since this is an Introduction to Investments class, we need to learn how these exotic and dangerous vehicles work, if only to protect ourselves and our loved ones from succumbing to their “get-rich-quick” siren calls. Before you start, please have the Options Notes Sheet handy. Get ready to be bedazzled, dazed, and confused by stock options!

Presentation file - Study guide

12.1: What are Options Contracts?
What are options contracts? They are securities that we should stay far, far away from. However, since this is an Introduction to Investments class and textbook, we need to become familiar with these gambles, ooops!, sorry, I mean, speculations, if only to know how to protect ourselves and our family members, friends, and colleagues from succumbing to their siren song of "get rich quick."
12.2: Options Characteristics and the Breakeven Point
Options contracts have various characteristics that set them apart from other securities. Let's explore them and specifically, let's learn how difficult it is to actually make money gambling, uh, oh, there I go again!, sorry, speculating with options.
12.3: Options Strategies; Covered Calls and Naked Puts
Oh, boy! Just wait until we regale you with all the ways you can lose a lot of money and make your broker rich, ooops!, I am so sorry, I meant get fabulously wealthy in no time at all with these sure-fire, fail-safe, gotta'-us-'em, options strategies. (Ah, Folks. This is called irony. I am being sarcastic. Got it? Good!)
12.4: Employee Stock Options and Some Final Topics about Options
Finally, let's take a look a type of option that is popular with high-tech companies, Employee Stock Options, often abbreviated as ESOs. We will also discuss a few other types of options and make some final comments about why you should stay far away from them.
12.S: Summary
Congratulations ‒ You Have Finished Chapter 12 ‒ Options Contracts

"Spin" by conorwithonen is licensed under CC BY 2.0