Call option

Examples of Call option in the following topics:

• Options Contract

  • Options contracts are defined as either call or put options.
  • Option holders must pay a fee, called the option premium.
  • Consequently, the option issuer charges a greater option premium for both calls and puts.
  • Call option has a strike price of $0.3 US / ringgit.
  • Did you notice something strange about the call and put options?

• Chapter Questions

  • You are holding 10 call options for petroleum with a strike price of $75 per barrel.
  • Option premium equals $0.5 per barrel, and each contract specified a quantity of 1,000 barrels.
  • Compute the premium, and whether you will exercise this option if the market price is $50 per barrel?
  • A farmer bought 100 put options for corn.
  • Calculate the farmer's premium, and whether he will exercise this option if the market price of corn equals $6 per bushel?

• Call Provisions

  • Occasionally a bond may contain an embedded option.
  • That is, it grants option-like features to the holder or the issuer.
  • Since call option and put option are not mutually exclusive, a bond may have both options embedded.
  • Price of callable bond = Price of straight bond – Price of call option
  • Price of a callable bond is always lower than the price of a straight bond because the call option adds value to an issuer.

• Other Considerations in Capital Budgeting

  • The real option creates economic value by generating future decision rights for management.
  • The notion of real options was developed from the idea that one can view firms' discretionary investment opportunities as a call option on real assets, in much the same way as a financial call option provides decision rights on financial assets.
  • Another value-creating aspect of real options can be found in abandonment.
  • Such future discretionary investment opportunities are known as growth options.
  • Projects with real options can be evaluated using a range of possible profits.

• Black-Scholes Formula

  • The Black-Scholes formula is a way of pricing a European option.
  • The Black-Scholes formula is a way of pricing a European option (an option that can only be exercised at its expiration date).
  • This hedge is called delta hedging and is the basis of more complicated hedging strategies such as those engaged in by investment banks and hedge funds.
  • The Black-Scholes formula where S is the stock price, C is the price of a European call option, K is the strike price of the option, r is the annualized risk-free interest rate, sigma is the volatility of the stock's returns, and t is time in years (now=0, expiry=T).
  • An example of prices of a European call option over time as predicted by the Black-Scholes formula.

• Employee Stock Compensation

  • An employee stock option (ESO) is a call (buy) option on a firm's common stock, granted to an employee as part of his compensation.
  • A company offers stock options due in three years.
  • An employee stock option (ESO) is a call (buy) option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package.
  • The holder of the option should ideally exercise it when the stock's market price rises higher than the option's exercise price.
  • ESOs have several different features that distinguish them from exchange-traded call options:

• Defining Options and Their Valuation

  • An option that conveys the right to buy something at a specific price is referred to as a call; an option that conveys the right to sell something at a specific price is called a put.
  • Whether the option holder has the right to buy (a call option) or the right to sell (a put option).
  • Exotic option – any of a broad category of options that may include complex financial structures.
  • Nearly all stock and equity options are American options, while indexes are generally represented by European options.
  • A European call valued using the Black-Scholes pricing equation for varying asset price S and time-to-expiry T.

• Overview of Warrants

  • Warrants are very similar to call options.
  • For instance, many warrants confer the same rights as equity options, and warrants often can be traded in secondary markets like options.
  • When a call option is exercised, the owner of the call option receives an existing share from an assigned call writer.
  • Warrants are not standardized like exchange-listed options.
  • This erosion of time value is called time decay.

• Importance of the Time Value of Money

  • You are given two options on how to receive the money.
  • Option 2: Get paid $600,000 every year for the next 10 years.
  • In option 1, you get $5,000,000 and in option 2 you get $6,000,000.
  • By figuring out how much option 2 is worth today (through a process called discounting), you'll be able to make an apples-to-apples comparison between the two options.
  • If option 2 turns out to be worth less than $5,000,000 today, you should choose option 1, or vice versa.

• Sinking Funds

  • Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.
  • The firm may repurchase a fraction of outstanding bonds at a special call price associated with the sinking fund provision (they are callable bonds).
  • The firm has the option to repurchase the bonds at either the market price or the sinking fund price, whichever is lower.
  • At best some indentures allow firms to use a doubling option, which allows repurchase of double the required number of bonds at the sinking fund price.
  • However, if the bonds are callable, this comes at a cost to creditors, because the organization has an option on the bonds: The firm will choose to buy back discount bonds (selling below par) at their market price,while exercising its option to buy back premium bonds (selling above par) at par.