D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Chapter 2: The Structure of Options Markets

If the financial markets are a war zone, this is the theater of If the financial markets are a war zone, this is the theater of hand-to-hand combathand-to-hand combat..

Richard ThomsonRichard ThomsonApocalypse RouletteApocalypse Roulette, 1998, p. 49, 1998, p. 49

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Important Concepts in Chapter 2 Definitions and examples of call and put optionsDefinitions and examples of call and put options Institutional characteristics of options marketsInstitutional characteristics of options markets Options available for tradingOptions available for trading Placing an options orderPlacing an options order The clearinghouseThe clearinghouse Accessing option price quotationsAccessing option price quotations Transaction costsTransaction costs Regulation of options marketsRegulation of options markets Margins and taxes in option transactionsMargins and taxes in option transactions

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Option terminologyOption terminology price/premiumprice/premium call vs. putcall vs. put exercise price/strike price/striking priceexercise price/strike price/striking price expiration dateexpiration date

Everyday examples of optionsEveryday examples of options rain checkrain check discount coupondiscount coupon airline ticket with cancellation rightairline ticket with cancellation right right to drop a courseright to drop a course

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Development of Options Markets

Early originsEarly origins Put and Call Brokers and Dealers AssociationPut and Call Brokers and Dealers Association Chicago Board Options Exchange, 1973Chicago Board Options Exchange, 1973 Resurgence of over-the-counter marketResurgence of over-the-counter market

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Call Options

Current exampleCurrent example Objective of a call buyerObjective of a call buyer Moneyness conceptsMoneyness concepts

In-the-moneyIn-the-money Out-of-the-moneyOut-of-the-money At-the-moneyAt-the-money

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Put Options

Current exampleCurrent example Objective of a put buyerObjective of a put buyer Moneyness conceptsMoneyness concepts

In-the-moneyIn-the-money Out-of-the-moneyOut-of-the-money At-the-moneyAt-the-money

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Over-the-Counter Options Market

WorldwideWorldwide Credit riskCredit risk Customized termsCustomized terms Private transactionsPrivate transactions UnregulatedUnregulated Options on stocks and stock indices, bonds, interest rates, Options on stocks and stock indices, bonds, interest rates,

commodities, swaps & currenciescommodities, swaps & currencies

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Organized Options Trading

Listing RequirementsListing Requirements Contract SizeContract Size Exercise PricesExercise Prices Expiration DatesExpiration Dates Position and Exercise LimitsPosition and Exercise Limits

The concept of an options exchange

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Options Exchanges and Trading Activity

See See Table 2.1, p. 29Table 2.1, p. 29 for options exchanges for options exchanges

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Option Traders

The Market MakerThe Market Maker Bid, ask, and bid-ask spreadBid, ask, and bid-ask spread Scalpers, position traders, spreadersScalpers, position traders, spreaders

The Floor BrokerThe Floor Broker Designated primary market makersDesignated primary market makers Dual tradingDual trading

The Order Book OfficialThe Order Book Official Limit ordersLimit orders Electronic order processingElectronic order processing

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Options Traders (continued) Other Option Trading SystemsOther Option Trading Systems

SpecialistsSpecialists Registered options tradersRegistered options traders Electronic trading systemsElectronic trading systems

Off-Floor Option TradersOff-Floor Option Traders Cost and Profitability of Exchange MembershipCost and Profitability of Exchange Membership

See See Figure 2.1, p. 32Figure 2.1, p. 32 for CBOE seat prices for CBOE seat prices Leasing a seatLeasing a seat High risk, stressful workHigh risk, stressful work

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Mechanics of Trading

Placing an Opening OrderPlacing an Opening Order Types of ordersTypes of orders

The Role of the ClearinghouseThe Role of the Clearinghouse The Options Clearing Corporation (OCC)The Options Clearing Corporation (OCC) Clearing firmsClearing firms See See FigureFigure 2.2, p. 342.2, p. 34 Margin (see Appendix 2.A)Margin (see Appendix 2.A) Open interestOpen interest

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Mechanics of Trading (continued)

Placing an Offsetting OrderPlacing an Offsetting Order In the exchange-listed options marketIn the exchange-listed options market In the over-the-counter options marketIn the over-the-counter options market

Exercising an OptionExercising an Option European vs. American styleEuropean vs. American style AssignmentAssignment Cash settlementCash settlement

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Option Price Quotations

See web sites of newspapers and options exchangesSee web sites of newspapers and options exchanges ProblemsProblems

Delayed informationDelayed information Nonsynchronized pricesNonsynchronized prices

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Types of Options Stock OptionsStock Options Index OptionsIndex Options Currency OptionsCurrency Options Other Types of Traded OptionsOther Types of Traded Options

interest rate optionsinterest rate options currency optionscurrency options options attached to bondsoptions attached to bonds exotic optionsexotic options warrants, callable bonds, convertible bondswarrants, callable bonds, convertible bonds executive optionsexecutive options

Real OptionsReal Options

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Transaction Costs in Option Trading

Floor Trading and Clearing FeesFloor Trading and Clearing Fees CommissionsCommissions Bid-Ask SpreadBid-Ask Spread Other Transaction CostsOther Transaction Costs

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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The Regulation of Options Markets

Federal regulationFederal regulation Industry regulationIndustry regulation Over-the-counter market regulationOver-the-counter market regulation The issue of which agency has regulatory responsibility The issue of which agency has regulatory responsibility

has occasionally arisen.has occasionally arisen.

Summary

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Appendix 2.A: Margin Requirements

DefinitionsDefinitions MarginMargin Initial marginInitial margin Maintenance marginMaintenance margin

Margin Requirements on Stock TransactionsMargin Requirements on Stock Transactions Margin Requirements on Option PurchasesMargin Requirements on Option Purchases Margin Requirements on the Uncovered Sale of OptionsMargin Requirements on the Uncovered Sale of Options Margin Requirements on Covered CallsMargin Requirements on Covered Calls

D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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Appendix 2.B: Taxation of Option Transactions

Taxation of Long Call TransactionsTaxation of Long Call Transactions Taxation of Short Call TransactionsTaxation of Short Call Transactions Taxation of Long Put TransactionsTaxation of Long Put Transactions Taxation of Short Put TransactionsTaxation of Short Put Transactions Taxation of Non-Equity OptionsTaxation of Non-Equity Options Wash and Constructive SalesWash and Constructive Sales

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D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed.

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