Investment and Portfolio Management BAF106

OPTIONS AS AN INVESTMENT
Investment and Portfolio Management BAF106
Market Interest Rate Analysis
Essentials of options:

Option is a type of contract between 2 persons where one person grants the
other person the right to buy or to sell a specific asset at a specific price
within a specific time period. The most often options are used in the trading of
securities.

Option buyer is the person who has received the right, and thus has a
decision to make. Option buyer must pay for this right.

Option writer is the person who has sold the right, and thus must respond to
the buyers decision.
Investment and Portfolio Management BAF106
Market Interest Rate Analysis
Types of option contracts:

Call option. It gives the buyer the right to buy (to call away) a specific number of
shares of a specific company from the option writer at a specific
purchase price at any time up to including a specific date.

Put option. It gives the buyer the right to sell (to put away) a specific number of
shares of a specific company to the option writer at a specific selling
price at any time up to including a specific date
Investment and Portfolio Management BAF106
Market Interest Rate Analysis
Option contract specifies four main items:

1) The company whose shares can be bought or sold;

2) The number of shares that can be bought or sold;

3) The purchase or selling price for those shares, known as the exercise price
(or strike price);

4) The date when the right to buy or to sell expires, known as expiration date
Investment and Portfolio Management BAF106
Market Interest Rate Analysis
Types of call and put options:


European options can be exercised only on their expiration dates.



American options can be exercised any time during their life (defined by the
option contract).
Investment and Portfolio Management BAF106
Market Interest Rate Analysis
The major advantages of investing in options:

possibility of hedging: using options the investor can lock in the box his/
her return already earned on the investment;

the option also limits exposure to risk, because an investor can lose only a
set amount of money (the purchase price of option);

put and call options can be used profitably when the price of the underlying
security goes up or down.

The major disadvantages of investing in options:
the holder enjoys never interest or dividend income nor any other ownership
benefit;

because put and call options have limited lives, an investor have a limited
time frame in which to capture desired price behavior;

this investment vehicle is a bit complicated and many of its trading
strategies are to complex for the non-professional investor.