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0:04
Jason Heavilin: In this video, we are going to do an overview of Jason Heavilin: options and a little bit on how Jason Heavilin: they are part of the corporate finance realm.
0:22
Jason Heavilin: So options an option gives the hold to the right. Jason Heavilin: but not the obligation, and that's the important part, not the obligation to buy or sell a given quantity of an asset on or before a given date, at prices agreed upon today.
0:40
The Jason Heavilin: quick, simple example is. I can enter into an agreement or contract with another person. Same.
0:55
Jason Heavilin: here is a premium. Here's a little bit of money for you to give me the option. the opportunity, but not delegation. to buy Jason Heavilin: certain amount of shares from you at this price. regardless of what the price in the market is, you agree to sell it to me. and I'll buy it from you Jason Heavilin: for a specific price that we agree with today. Now I will have, let's say, a 3 month window. The time varies
1:29
Jason Heavilin: for me to decide if I want to buy it or not. Jason Heavilin: If I choose to buy it, regardless of the price on the market, you will sell it to me for that price. Jason Heavilin: or I just say, like, you know what? I don't want to buy it. Keep the money I gave you, the premium that fee that I gave you for having that possibility of buying it at a certain price.
1:53
Jason Heavilin: Now, the other party. it's obligated to sell it to me if I choose to buy it. That's why they collected their feet. So exercising the option, the act of buying or selling the underlying asset. That's when I if I just said, Okay, I will buy it for the price. Then I'm exercising the option.
2:11
Jason Heavilin: Other terms are strike price or exercise price. That is that Jason Heavilin: right? So what you agreed on. That's the price I'll buy from you. That's the price for sell it to me, regardless of what prices on the market expiration date, let's say the 3 months go by Jason Heavilin: A in our example, and I decided not to buy it. Then it expires, and the other person keeps the fee.
2:36
Jason Heavilin: and doesn't have to sell it to me. After that, if I want to still have that option, I have to buy another one again for a fee.
2:49
Jason Heavilin: And that example there we just Jason Heavilin: talked about. That's what's called a call option.
2:58
Jason Heavilin: So there are 2 flavors of options out there, European and American options. European options can be exercise only at the expiry date. So if we agreed in 3 months from now, I would have to wait the 3 months before I tell the person. Okay, I'll buy it.
3:17
Jason Heavilin: Now, that does not mean that I cannot sell the optional contract. This option trading slightly different conversation. because the value of an option Jason Heavilin: does go up and down as time goes by. a lot of factors impact it. We'll talk about that later. But I can sale, the option to the person for that other person to have the the right, but not the obligation to exercise
3:46
Jason Heavilin: an Expiration day. That's European the American option can be exercised at any given time. So with the American option, you have more flexibility. You can either buy or so the option some of the person.
3:59
and or you can go and exercise it at any given time. You do not have to wait. At the end of the 3 months you can do it a weekend 2 weeks in 3 months. It exercising the option Jason Heavilin: would result in a positive payoff. I'm gonna change the way they're rephrasing that because it doesn't mean that every time you exercise an option you're gonna make money. Now, what they're saying is that the only time people exercise the option is when there's a positive payoff.
4:31
Jason Heavilin: For example. if I agreed. or the option I purchase of the person agreed to sell me the stock, or they say $50 and and the market. This talk is up to up to $55. Then yes, I will exercise the option, so I can buy for 55.
4:50
Jason Heavilin: But the reason that I made money is because it was already money to be made. There was a possible payoff, not because I exercised it so. The way that sent to the structure sounds like. If you exercise it, you make money. No, if there's an opportunity to make money, then you exercise it.
5:06
So That is what in the money means Jason Heavilin: at the money exercising the option will result in a 0 payoff meeting. That is a break even point at that point, whether you excise or not, you end up with it. Same result. Jason Heavilin: Most people don't exercise that at the money they just let it ride. Let it go? Because what's the point
5:32
Jason Heavilin: out of the money? That is, when the prices and the stock in the market is not in your favor. If you, for some reason exercise it. You will lose money. But no, you wouldn't exercise it. Jason Heavilin: You would just let it go.
5:46
Jason Heavilin: Now. These definitions that you see here in the money at the money out of the money. Jason Heavilin: They do not take in consideration the fee the person pays to get to but purchase the option contract. This is just strictly talking about the exercise price versus Jason Heavilin: the the price on the market. Jason Heavilin: However, once you factor in that fee that you paid, you'll have to overcome the fee
6:16
Jason Heavilin: before you actually start making money. We'll talk more about that in a few moments.
6:23
Jason Heavilin: So more on call options, call options. Give the hold of the right, but not the obligation to body, but giving quantity of some assets owner before sometime in the future. pretty much like some. What we spoke about the reason why isn't bold? Because later we'll talk about the put option, which is the the flip side where you sell it instead of buying it.
6:46
Here's a graph Jason Heavilin: showing what they talk about. When are you in the money or out of the money, etc., this one is not taken into account the premium that fee that I spoke about. So this is without fee. Jason Heavilin: What happens is, they have a situation where the excise price of $50. So, as we mentioned before. Jason Heavilin: and there's a call option, and you're on the by side.
7:12
Jason Heavilin: If this stock price in the market is less than $50 you would not exercise, because you will lose money. So there's 0 profit. That's where the 0 there, that's what you would be. But as soon as I remember this, without any fees included. As soon as it goes above $50, then you start making money. Jason Heavilin: you would exercise the option, and you'll make the difference between the 50 and the actual market price.
7:43
No.
7:45
Jason Heavilin: regarding profits. Jason Heavilin: Here's an example. You have to overcome. The premium premiums vary. It depends on the on the type of security and the length of the option, etc. But on this example this premium is $10. So you go ahead and pay $10 to have the right to this option. If it doesn't work out and you don't exercise it, you let it go. The $10 are gone. So that's what they show you here
8:11
Jason Heavilin: that now you have to reach $60 to overcome the premium and then start making money. Jason Heavilin: Okay, so here the premium is not included. So anything about $50 to start making money, and if you don't, there's no laws, because there was no premium. But the reality is that there is premiums. And now you have to overcome Jason Heavilin: the premium.
8:36
Jason Heavilin: So anything below 50 you would an excise, for sure, because it just increases your loss beyond the $10, so that will be the maximum loss you will have will be the premium
8:47
Jason Heavilin: between 50 and 60.
8:51
Jason Heavilin: It is below 0, but you would want to exercise it, and the reason is because at least you recover some of your $10. Let's say it's about to expire. Jason Heavilin: and there's no signs that's gonna go about 60.
9:05
Jason Heavilin: Then the last minute you can go ahead and and exercise that anyways. So at least you recover some of the $10. So notice your lost starts going down. Your. The layer is going up, the line is going up, but that's because you but what it's doing is reducing, reducing your losses. Jason Heavilin: So your Jason Heavilin: loss becomes less and less of the $10
9:29
Jason Heavilin: until you hit the $60 mark where you at least would recover your $10 anything above 60. You have recovered the $10, plus you're making money about it.
9:41
Jason Heavilin: So, clearly speaking, anything about 50, you still want to exercise, but one is for
9:48
Jason Heavilin: minimizing losses.
9:51
Jason Heavilin: And then beyond this point, we'll actually be profitable.
9:56
Jason Heavilin: Put options. This would be similar to short selling stock, or at least the same cost of applies. You make money. When you buy a put option, you make money if the stock price goes down. Jason Heavilin: So by definition. Put options, give the hold or the right, but not the obligation
10:16
Jason Heavilin: to sell a given quantity of an asset on or before, sometime in the future at prices agreed upon today, when exercising a put, you put the asset to somewhat. yes, those are the words in the terms they came out with. Jason Heavilin: So Jason Heavilin: when you buy a put option, you are a green. Jason Heavilin: or let's put it this way, somebody. It's a Jason Heavilin: agreeing to buy it from you
10:46
Jason Heavilin: at a specific price. You're not buying it now you're selling to the person, but they're the ones I will if you buying the the put option. They wrote the option, and what they're saying is, if you give me the fee.
10:58
Jason Heavilin: I agree to buy this stock from you a certain price. So if you think the stock price is going to go down this. How you make money. Jason Heavilin: Let's say you get an a put option. The other party agrees to buy from you at $50. Jason Heavilin: So the start price goes down to 45 you would exercise because that person will buy you from your $50.
11:20
Jason Heavilin: So what you do you exercise it? So now you buy this stock of 45, and they agreed to pay 50 for it. So you make the difference. So now you kinda like on the other side, but you are still paying the fee. So you have the option to do this or not you? You're not obligated to do it. Jason Heavilin: but they're obligated to buy from you at that price.
11:40
so the chart will look differently. Jason Heavilin: This is the example. Where is the start price
11:49
Jason Heavilin: and the market is about $50, Jason Heavilin: and that other party agreed to buy you from your 50. You don't want to exercise it, because you will have to buy it for 60, 80, or $100 in this, up to them for 50 Jason Heavilin: you will lose money. Jason Heavilin: but since you're the one that paid the fee. You're not obligated to sell it to them by 50, but they're obligated to buy it from you 50 if you exercise.
12:13
So what happens is my example that I mentioned earlier. If it drops to 45, let's say you start making money. Jason Heavilin: and as the stock price drops
12:23
Jason Heavilin: you can make more and more money theoretically, and the stock price drops to 0, you'll make the entire $50.
12:31
Jason Heavilin: Now notice the key difference here between this Jason Heavilin: and this. When you buy a call option. This line could go up to infinity. theoretically speaking, so your losses
12:48
Jason Heavilin: or minimize, but that I can go up to infinity Jason Heavilin: same here. Your losses will be captured at $10. That's the most. You will lose the premium. But Jason Heavilin: the stock price could go up to infinity. So theoretically, you can make money infinite amount.
13:05
Now the thing with a put option is. Jason Heavilin: you profit
13:11
Jason Heavilin: has a maximum, so it's the flip side. Your profit has a maximum of whatever that strike price was. So the most money you can make
13:24
Jason Heavilin: if it goes to 0 in this case, after the premium of $10 is $40. So the maximum profit is a strike price minus the premium that you paid. So there is a maximum profit here. There was an infinite profit Jason Heavilin: and a minimum law or maximum loss. Here it flips. There's a maximum profit, but the loss could be infinite, depending. But
13:50
Jason Heavilin: because you don't have to exercise.
13:54
Jason Heavilin: your loss will still be just the premium.
13:58
Jason Heavilin: So that's the big difference
14:01
Jason Heavilin: here. Yes, your losses are the premium, but your profit has a limit
14:08
Jason Heavilin: here. Your Jason Heavilin: losses are still just the premium. Jason Heavilin: but your profits are unlimited.
14:17
Jason Heavilin: However, in a bear market this will be the way to make money. because this will not be really an option, because we're an opportunity, because there's a better market. Prices are going down.
14:33
Jason Heavilin: So now, if you are the one selling the option of the writer so same things that we spoke about. But you're on the other side now. You're the one selling the the contract and collecting the fee. So all that does is pretty much flips your situation. Jason Heavilin: If you are buying the call option when you buy it, and you pay the fee, you make money. This stock price goes up. But if you are the person that sold the call option, you collected the fee.
15:04
Jason Heavilin: you're better off if the price does not go up. because then it will be exercise Jason Heavilin: and the flip side here. If you're the one that sales the put option, you collect the fee. Jason Heavilin: you better off if the stock price goes up.
15:21
Jason Heavilin: Now, combination of options. So what happens is you can go ahead and do combinations of different options with different prices and different strike prices I should say different strike prices and different premiums of fees, and do some improve your profitability
15:43
Jason Heavilin: by doing combinations. put some calls to service the building blocks for more complex option contracts. If you understand this, you become a financial engineer. Tell you the risk, return profile to meet your clients needs now Jason Heavilin: 2 things you can do trading strategies and offices by combining them. But from the corporate side perspective options are a great tool to hedge
16:04
Jason Heavilin: the the positions of a company on their projects and and things like that, for example. they always the famous there was a it was with an option. Some of the future contract. But South was their lines Jason Heavilin: used This type of contract. A derivative is what we call it. in order to hedge changes in fuel prices. So you can do that same with options.
16:30
Jason Heavilin: You can lower your risk of your company through hedges with options and combinations of options.
16:38
Jason Heavilin: Then we have valerine options. As I mentioned earlier, you can trade options. You can go ahead and get into an option, and before it expires. Jason Heavilin: and you have not exercise it yet. You can just sell the option to the person, and the reason is because the option has other elements that add value to it. So sometimes selling the option is more profitable than exercising the option.
17:06
Jason Heavilin: There's a lot of other factors going play there. That's more for another class. A durators class Jason Heavilin: a more advanced class in in securities. But understand that Jason Heavilin: if I go ahead and buy an option
17:20
Jason Heavilin: it could be in the money. but because there's other things that add value to the options and star deviation, and the time left on the option, etc. The selling, the option may bring me more money than exercising the option, as we explain before. Jason Heavilin: so value in them. It's a different way to catch a different calculation, a different way to value. Then you would like with stocks, for example.
17:48
No, these are the things that can bring the value up or down Jason Heavilin: of of an option, it does it at different degrees. But these are it. So if this, if you're buying these, these are based on, if you are the buyer of the option of the seller, I spoke earlier. So if you're buying a call option
18:08
Jason Heavilin: and the stock price goes up this the call option goes up the value because that one makes money when the price goes up. But if you buy a put option, you were in a position that you wanted to stock price to go down. Jason Heavilin: So the stock price goes up. The value. The put option is going to go down
18:28
Jason Heavilin: exercise price Jason Heavilin: the higher the exercise price, the lower the value, the call option, because it's harder to reach that target. Jason Heavilin: but pass it, and opposite is true, because you want the stock price to go down. In this case interest rates. If they go up, the call offers go up, the puts go down. The value Jason Heavilin: of volatility in this talk price in both situations. If volatility goes up the value, the option goes up.
18:57
Jason Heavilin: The simplest explanation, for that is because it increases the probability of a of of hitting the the excise price or passing it. Jason Heavilin: The more volatile it is. There's a higher chance of the pension to go in the money, but because of the higher chance. Then the value of the option goes up as volatility increases
19:20
Jason Heavilin: expiration date. The longer you have to wait for the stock price to move in your favor, then the higher the chances you eventually hit in that mark Jason Heavilin: so similar to volatility, the more time you have the more value. There is an option, because there's a higher chance of eventually hitting that target.
19:42
Jason Heavilin: And as time, then on time, you can stop at a hold it so time starts going by and reducing. So, as times go by that affects the value it starts decreasing the value. Now, these don't work in isolation. What happens is that they all changing well except the excise price, they all changing
19:59
Jason Heavilin: constantly, accept the exercise price so as they all change, they are going to change different rates. They all have different power and the impact on the value So a lot of things come in play. So the calculations include all these elements Jason Heavilin: in order to get evaluation. so sometimes they cancel each other out, or one is more overwhelming. etc. Now, there's a variety of ways to
20:26
Jason Heavilin: value an option. Jason Heavilin: A popular one right now is a black shows model. The people that invented this formula, or derived this for me, I should say one a Nobel prize in economics for it. And it's a it's the popular one out there. Jason Heavilin: This formula here just pretty much explain the variables and how to calculate it. we will have a different video or an excel sheet going through an example. So we understand how the formula works.
20:54
Jason Heavilin: That will be it for this video. See you on the next one.
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