The Mathematics of Money

282 Chapter 6 Investments

The Options Market

There is really no theoretical reason why an option could not be written for any number

of shares at any price someone might want to buy an option for. However, for the same

reasons as for futures, there are many benefits to having only a certain set of standardized

options available. Such options are listed on one or more options exchanges, such as the

Chicago Board Options Exchange (CBOE).

Options are offered with certain prices at which they can be exercised (called strike

prices) and certain expiration dates (options often expire on the third Friday of each month).

If you are interested in buying an option, you may select from any of the various combina-

tions of strike prices and expiration dates that are available. A quote listing these is known

as an option chain. An example of such a chain is shown below:

GANARGUA HYDRO CORP—CALLS

Date Strike Last Bid Ask Vol Open Int

Oct ‘06 30 9.23 9.20 9.25 66 350

Oct ‘06 35 4.18 4.16 4.21 221 1087

Oct ‘06 40 2.25 2.23 2.27 107 502

Oct ‘06 45 1.18 1.18 1.20 35 205

Oct ‘06 50 0.65 0.61 0.65 0 4

Nov ‘06 30 10.37 10.34 10.39 11 87

Nov ‘06 35 5.06 5.04 5.09 105 935

Nov ‘06 40 3.55 3.53 3.57 67 772

Nov ‘06 45 2.17 2.17 2.19 195 602

Nov ‘06 50 1.08 1.04 1.08 2 21

The last price shown in the table is, as one would expect, the last price at which a sale of the

given contract occurred. The bid price is the highest price that is currently being offered for a

contract with the given expiration and strike price; the ask price is the lowest price that is cur-

rently being offered for such a contract. The volume gives the current day’s number of contracts

traded; the open interest is the total number of contracts which are currently in existence.

The prices quoted for options are normally a price per share of the underlying stock. Each

contract, though, is usually the right to buy or sell 100 shares of the underlying stock.

Example 6.3.9 Kevin bought three November contracts to buy shares of Ganargua

Hydro Corp. at 35 at the best price available for the option chain shown above. How

much did he pay?

For the November contract, the ask price was 5.09. Since each contract represents the right

to buy 100 shares, the price for each contract was $509. The total amount paid would then

be 3($509) 
 $1,527.

You may have heard of stock options on the news in stories about their use as part of the

compensation paid to executives of large companies. Many companies offer their execu-

tives call options on the company’s stock either as part of their compensation or at attractive

prices. The theory behind this is that if the executive stands to benefit from a rise in the com-

pany’s stock price, she will have a strong incentive to manage the company in a way that

makes this happen, benefiting all of the shareholders. Critics of this practice complain that

these options are often set up in such a way, though, that executives can reap huge financial

rewards from fairly modest moves in the stock price, due to the leverage options offer, and

that if the price declines the executive’s risk is limited to her options expiring worthless.

Abstract Options and Futures

Futures are usually settled in cash; options are typically settled in the same way. Consider

the scenario from Example 6.3.6, where you had a call option for 100 shares of Yoyodyne