Derivatives

CHAPTER 14Options Markets

Aims

• To discuss the organisation of options markets including the role of the clearing house and interpreting newspaper quotes.
• To consider the payoffs at maturity for long and short positions in calls and puts.
• To show how options can be used for (i) speculation and (ii) providing insurance against adverse outcomes, while allowing the investor to also benefit from any ‘upside’.
• To explain some terminology applied to calls and puts, such as in-the-money (ITM), at-the-money (ATM) and out-of-the-money (OTM), as well as intrinsic value and time value.

14.1 MARKET ORGANISATION

Options are traded on individual stocks, stock indices, commodities (e.g. crude oil, gold), foreign currencies, futures contracts and to a much lesser extent on Treasury notes and Treasury bonds. The major exchanges for financial options, are the Chicago Board Options Exchange (CBOE) and the Philadelphia Stock Exchange (PHLX) in the US and Intercontinental Exchange in London. The CBOE was established in 1973, initially trading stock options. It is the largest organised options market, trading standardised contracts and has a deep secondary market.

The over-the-counter (OTC) options market tailors the option contract to the buyer's specifications and is now very large and probably over 10 times larger than the exchange traded options market – although often the secondary OTC market is thin. However, some active secondary OTC markets do exist, particularly the market in European ...