Options on equity / share market instruments

Introduction

We repeat our illustration on options introduced earlier for the sake of orientation (see Figure 17). Options on equities may be divided into the following categories:

• Options on specific equities.

• Options on equity / share indices.

• Equity / share warrants (call options).

• Equity / share warrants (retail options).

• Redeemable preference shares.

options

Figure 17: options

Examples of the options in the first two categories are shown in Table 11 for the US market. The many different exchanges involved in these markets will be noted. It is obvious that these markets are exchange-traded, but it should be pointed out that there is also an OTC market in shares and these and other indices.

Exchange

Share / index

Options on shares (stocks in US)

CBOE

Many specific shares (stocks)

AM

Many specific shares (stocks)

PB

Many specific shares (stocks)

PC

Many specific shares (stocks)

NY

Many specific shares (stocks)

Options on share (stock in US) indices

CBOE

Dow Jones Industrial Average

CBOE

NASDAQ 100

CBOE

S&P 100 index

AM

Major market index

PB

Gold

PB

Oil service index

PB

Utility index

CBE = Chicago Board of Trade. CME = Chicago Mercantile Exchange. LIFFE = London International Financial Futures Exchange.

CBOE = Chicago Board of Option Exchange. AM = American Exchange. PB = Philadelphia Exchange. PC = Pacific Stock Exchange.

NY = New York Stock Exchange.

Table 11: Examples of US market options on equities

Options on specific equities

There are many exchanges in the US and the UK (and other markets including the JSE) that list and trade options on specific equities. Such options are usually written on the shares that have a large market capitalisation, and are well traded (i.e. liquid). An example is required (see Table 12).57

360

27.0

33.0

38.5

0.5

7.5

12.5

6.5

14.5

22.0

10.0

22.0

27.0

Table 12: Lloyds TSB equity / share options (quoted on liffe) (current price 384 pence)

In this example there are two strike prices, i.e. 360 pence and 390 pence at a time when the share in trading at 384 pence. The limited number of strike rates and contract maturity dates ensure that there is liquidity in the option contracts.

There are two sets of prices quoted, i.e. one for call options and one for put options. For example, the June call price at a strike price of 390 is 22.0 pence. This means that a buyer of this call option will pay 22 pence per share. The minimum contract size is 100 shares; thus the option contract will cost the buyer GBP 220 (i.e. the premium). The buyer of the call has the right but not the obligation to buy 100 Lloyds shares at a price of 390 pence and the cost of the option is GBP 220. Alternatively, a June put option at a strike price of 390 will cost GBP 270, and this will bestow upon the buyer the right to sell 100 Lloyds shares at a price of 390 pence at any stage up to the expiry date of the option in June.

The markets in options on individual shares are large, and they are usually exchange-traded. There are also OTC markets in options on individual shares.

There is also an option that is a hybrid of an exchange listed option and an OTC option in that it is listed but has the flexibility of an OTC option: the so-called Can-Do Option. It is designed to provide fund managers with a means to tailor derivatives to their particular exposures.

The following features distinguish it from other options on equities:

• Minimum contract size = large (usually the local equivalent of USD 1 million indicating that it is aimed at the professional investor).

• Contract size = any amount over local equivalent of USD 1 million.

• Underlying instruments = basket of shares can be specified by the investor.

• Expiry date = specified by the investor.

• Settlement = cash or physical at the option of the investor.

 
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