Date: Monday, April 2, 2007
Read:
1. Option Contracts and Their Valuation (UVA-F-1519)
2. Stock Options and Compensation (UVA-F-1521)
3. BMA, Chapter 20 (Supplemental Reading)
4. Glance over the internet material on the CBOT and CBOE
Interesting information on the Chicago Board of Trade (CBOT) can be found at http://www.cbot.com where you can navigate to information about the exchange and pricing for a wide array of products.. For information on The Chicago Board Options Exchange (CBOE) see http://www.cboe.com which has lots of data and a helpful glossary on terms in the options markets (see the learning center tab).
Network File: None
Class Objective:
Introduce the basics of options and their valuation
Assignment:
1. What is a call option? What is a put option? Based on the Black-Scholes valuation exhibit in the note (including Appendix 2) please consider the following questions:
a. How does the value of a call option change as the time to maturity increases? What is the explanation?
b. How does the value of a call option change as the volatility increases? Why?
c. How does the value of a call option change as the stock price increases relative to the strike price? Why?
2. Using the Black-Scholes Model tables in the reading, what volatility is implied in the current call option prices on Apple Computer stock? How does this compare with the historic volatility of 0.4963?
3. What is your estimate of the value of the stock options awarded to the executives of Apple Computer in March 1999? What would have been the impact if the managers had received the same value of the option grants but in shares of Apple Computer?
4. What would the value of the option grants be if the volatility of Apple stock was estimated to be 0.20?
Note: When dealing with derivative contracts such as options, the general convention is to express interest rates using continuous compounding.