Options Assignment: Amazon.

com (AMZN)

John McNally

201215647

April 4, 2017
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Initial Observations:

According to options pricing theory the price of an option will be higher in the money,

still high at the money, and lower when it is currently out of the money. Longer times to maturity

will also make the option more expensive in comparison to shorter expiration dates. The

observations for options on AMZN will be different from the values gained from the

Black-Scholes model due to the American style of the options and the possible dividends that

they pay. To observe the change in price with time we can see that AMZN currently has a stock

price of $845.61, for an option with an expiration date of March 31, 2017 and a strike of $845

the call and put will be valued at $5.7575 and $5.0445 respectively since they are both in the

money. If we increase the expiration date to May 5, 2017 and hold the same strike price the

option prices increase in price to $28.1178 and $26.6386 for the call and the put given the longer

time to expiry there is a greater chance that the option may enter into the money.

When we look at the next option pairing of a call and a put with a strike of $825 and an

expiration date of March 31st we see that the call is way in the money and therefore much more

expensive than the out of the money put. With only 7 days to expiration this option has a very

little chance of the call going out of the money and this high probability also leads to a higher

option price.

The final option pairing of the call and the put with a strike of $875 will mean that the

opposite occurs and the put is deep in the money and therefore very expensive. As one would

assume if the put is deep in the money the call is very out of the money. We can see that as an

option goes farther and farther out or in to the money the effect of different variables have less of

an effect compared to an option that is not as far in or out of the money.

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The Greeks:

The Greek values calculated for these options provide key insights into their valuation.

All graphics depicting the Greeks and how they are affected with the passage of time are found

in Appendix A. Delta measures the sensitivity of an options perceived value to a change in the

price of the underlying asset. It has a range of between minus one and one, and it indicates how

much the price of the option will change when the price of the underlying stock increases by 1

dollar. For call options, delta will be positive and for put options, delta will be negative. When

varying just the strike price and time to maturity, the delta will fluctuate between -1 and +1.

When just varying the strike price you can see that when a call is in the money the delta will get

closer to +1 the more in the money it goes. When the call goes out of the money it will drop and

get closer and closer to zero. For an in the money put it will be the opposite, the delta will drift

closer and closer to -1 as it goes more in the money and drift closer and closer to 0 as it goes out

of the money. Appendix A contains a graph showing that with time the change to delta becomes

smaller and smaller. Initially in the first month of trading there is a large jump which implies that

the price of the option will change a fair bit for every change in the underlying asset.

The second Greek, Gamma, shows the rate of change in delta for every 1 point increase

in the underlying asset. For an at the money option, Gamma will be quite large and will get

progressively lower for both the in and out of the money options. Gamma is positive for both

puts and calls. When varying the strike price and time to maturity the Gamma will drift higher as

the option goes into the money and will drop down closer to zero as it goes out of the money. As

you can see below in Appendix A, it corresponds with the previous graph of delta because it
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shows that the rate of change in the prices will be much higher in the first month of trading and

then flatten out as time progresses.

Theta measures how to option will be affected with the passage of time. It is the dollar

amount that an option will lose each day. For an at the money option, theta increases as an option

approaches the expiration date. For in and out of the money options, theta decreases as an option

approaches expiration. Theta has an inverse relationship to Gamma with the graphs for both the

put and the call being essentially the same. Theta is always negative for both puts and calls

because it is assumed that no matter what, the option becomes worth less with each day that

passes. With the passage of time you can see that for the initial holding period the value of the

option is more drastically affected but as time increases the deterioration of value becomes less

pronounced.

Vega is a measure of how volatility affects the price of an option. Changes in volatility

will affect both calls and puts the same way. An increase in volatility will increase the prices of

all the options on an asset, and a decrease in volatility causes all the options to decreases in

value. The further the time to expiration the higher chance there is that the stock will become

more volatile and as a result the price of the option increases. As seen in the chart in Appendix

A, Vega increases steadily with time in turn increasing the price of all the available options.

Rho is the rate at which the price of an option changes relative to a change in the risk-free

rate. It shows how much the price of an option will be affected from every 1% increase in the

risk-free interest rate. Rho is said to be less useful than the other Greeks since for many options

contracts the interest rates mostly remain constant and have little effect on most short-term

contracts.
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Implied Volatilities:

The implied volatility was found through trial and error iterating through different values

with the options calculator found on TradingToday.com. We are assuming that there are 7 days

to expiry, a risk free interest rate of 0.79%, the yield on the 3 month US Treasury bill, and initial

stock price of $845.64, and an expiration date of March 31st.

The first option pair with an in the money call and an out of the money put with a strike

price of $825 had an implied volatility of ~16%. When increasing the price of the option by 10%

the volatility jumps up to 24% and when decreasing it by the same amount the volatility

decreases in order to mimic the price however, with the decrease in volatility the price of the

option can go no lower than $20. There is also a discrepancy between the Black-Scholes

calculation and the given option price implying that the CBOE must be incorporating early

exercise into their pricing model.

For the second option pair of an out of the money call and an in the money put, there was

an implied volatility of ~6.8%. When adjusting it by +/- 10% we get 16% and almost 0%

respectively. For the final option pairing with an expiration date of May 5th and a strike price of

$845 there will be an implied volatility of ~24%. Adjusting for +/- 10% gives us an implied

volatility of 29% and 12% respectively. The volatility based on different levels and times had

very little effect on the price of the options.

According to the laws surrounding the Greek Vega, we imply that the third option pairing

of the two in the money call and the put options with expiration of May 5th having Vegas of

1.1284 will be more affected by changes in volatility than the other two pairs. The first and

second option pairs will be less affected by these changes with 0.2366 and 0.0489 as their values
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for Vega. These numbers being close to zero indicate that for every 1% change in volatility the

option price changes very little compared to the third option pairing with a longer term to expiry.

It is clear that as the price increases it will imply there being a higher volatility and vice versa as

it decreases.
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Appendices

Appendix A:

Delta vs. Expiration Date (Out of the money call)

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Delta vs. Expiration Date (In the money put)

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Gamma vs. Expiration Date (For both a put and a call)

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Theta vs. Expiration Date (Call)

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Theta vs. Expiration Date (Put)

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Vega vs. Expiration Date (Call)

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Vega vs. Expiration Date (Put)

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Rho vs. Expiration Date (Call)

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Rho vs. Expiration Date (Put)