|Author||Topic: Overwhelmed by Options! Help/Advise?|
I'm completely overwhelmed by the options section for level 1! I'm using the CFA books and am having a hard time understanding the various intricacies of options (i'm fine with futures and forwards).
With regards to options, I understand the basic format of puts and calls and how one makes money off going long/short each one.. but am struggling with completely understanding the nuts and bolts of the section.. for example i'm struggling with:
1. the maximum and minimum values of European options and American options
2. how the max and min Values for options are different for the max/min Bounds for options
3. put-call parity
basically.. considering options are a small part of level 1, I don't feel like spending an inordinate amount of time studying for this section. Can anyone share how in-depth we need to know this section? For example, are we required to memorize the formulas for constructing synthetic options?
Thanks so much for your help!
there is not so much a difference... the boundaries are just a more strict refinement of the min/max values... in fact, if you compare those you will notice that the boundaries give a more strict minimum lower value for the option instead of just saying they must be >=0.
if you have problems deriving the results, dont worry, you're just expected to know the boundaries. although in my opinion, being able to derive results gives a more intuitive understanding..
i don't want to rewrite the passage from my AN study notes, but the general idea is as follows:
(for minimum Euro-call value)
that they create a portfolio out of stock, call option, and cash, which at maturity will always have a positive or zero value (depending on what the spot price is), thus it MUST have a positve value today (>=0).
then they just re-arrange the terms, i.e. solve for the call value.
the american call must be worth at least as much, because it gives more flexibility! i.e. C>=c
note that for a non-dividend paying stock, early exercise is not favourable..
(for minimum euro-put value)
same logic as with call. construction of a portfolio that yields +/0 payoff at maturity... this must be >=0. re-arrange..
for the american put however, early exercise might be favourable, thus in this case the lower value is different for the amercian option.
the logic is, that the a fiduciary call and a protective put at maturity will always have the same payoff, thus the two strategies must have an equal value.
fiduciary call (FC)= zero-bond (face=X) long + call long (strike=X)
protective put (PP) = stock long + put long (strike=X)
let's say S(T)>X (call has value, put doesn't)
alternatively, let's say S(T)
in present value terms: PV(X)+c(0)=S(0)+p(0) et voilą, here goes the PCP..
with synthetic options, do you mean building the tracking portfolio (a portfolio that has equal payoffs than the option; usually we need this for calculating arbitrage profits)? then yes, you are expected to know that... but good news, just re-arrange the PCP.