Strategic Risk Taking: A Framework for Risk Management

Appendix 8.1: Basics of Options and Option Pricing

An option provides the holder with the right to buy or sell a specified quantity of an underlying asset at a fixed price (called a strike price or an exercise price) at or before the expiration date of the option. Because it is a right and not an obligation, the holder can choose not to exercise the right and allow the option to expire. There are two types of options: call options and put options.

Option Payoffs

A call option gives the buyer of the option the right to buy the underlying asset at a fixed price, called the strike or the exercise price, at any time prior to the expiration date of the option. The buyer pays a price for this right. If, at expiration, the value of the asset is less ...