Chap15.Options on stock Indices and Currencies.pdf

Chapter 15: Options on stock indices and Currencies Dr. Zhipeng Yan Index Options The most popular underlying indices in the U.S. are ? The SP 100 Index (OEX and XEO) ? The SP 500 Index (SPX) ? The Dow Jones Index times 0.01 (DJX) ? The Nasdaq 100 Index (NDX) Exchange-traded contracts are on 100 times index; they are settled in cash; OEX is American; the XEO and all others are European. (/DelayedQuote/DQBeta.aspx) Call: (S – K)*100; Put: (K – S)*100 Index Option Example Consider a call option on an index with a strike price of 880 Suppose 1 contract is exercised when the index level is 900 What is the payoff? Using Index Options for Portfolio Insurance Suppose the value of the index is S0 and the strike price is K If a portfolio has a β of 1.0, the portfolio insurance is obtained by buying 1 put option contract on the index for each 100S0 dollars held If the β is not 1.0, the portfolio manager buys β put options for each 100S0 dollars held In both cases, K is chosen to give the appropriate insurance level Example 1 Portfolio has a beta of 1.0 It is currently worth $500,000 The index currently stands at 1000 What trade is necessary to provide insurance against the portfolio value falling below $450,000? 5 Example 2 Portfolio has a beta of 2.0 It is currently worth $500,000 and index stands at 1000 The risk-free rate is 12% per annum The dividend yield on both the portfolio and the index is 4% How many put option contracts should be purchased for portfolio insurance? Calculating Relation Between Index Level and Portfolio Value in 3 months If index rises to 1040, it provides a 40/1000 or 4% in 3 months Total return (incl. dividends) = 5% Excess return over risk-free rate = 2% Excess return for portfolio = 4% Increase in Portfolio Value = 4+3?1=6% Portfolio value=$530,000 Q: What if the index drops to 960? Determining the Strike Price Value of Index in 3 months Expe