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55 Cards in this Set

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What is a call option?
a call option is the right to buy
What is a put option?
a put option is the right to sell
What is the difference between an American and a European option?
An American option may be exercised at any time and a European may only be exercised at expiration.
What is the difference between buying (purchasing) and writing (selling) an option? What is the most that you can earn from writing an option?
Buying an option is purchasing an option and selling an option is writing the option. The seller retains the premium paid no matter how many times the option is sold. The most an seller can make is the premium
When buying an option, what are the three possibilities of what can be done with the option?
When you buy an option
a. You can exercise the option
b. You can sell the option
c. You can let the option expire unexercised
How do the following real world experiences relate to either a call or put option in terms of writing or buying an option?
a. As a shopper you place some merchandise on layaway.
place merchandise on lawaway- call option (buyer)
How do the following real world experiences relate to either a call or put option in terms of writing or buying an option?
b. “Satisfaction guaranteed or your money back” warranty.
satisfaction guarantee or your money back- put option (buyer) premium is embedded in the price
How do the following real world experiences relate to either a call or put option in terms of writing or buying an option?
c. Collision insurance on your car.
collision insurance on the car- put option (buyer)
How do the following real world experiences relate to either a call or put option in terms of writing or buying an option?
d. The call provision on a debenture. How is this priced in the bond?
call provision on a debenture- buyer is writing a call option, the bond pays a higher yield and this is the option premium.
How do the following real world experiences relate to either a call or put option in terms of writing or buying an option?
e. You decide to refinance your home loan at a lower interest rate. How is this priced in the loan?
put option- putting it back to the lender, lender bears the risk <interest rates are higher than they need to be> embedded.
What is the primary difference between a stock option and an index option?
Stock option- A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date. Index options- are based on a stock index rather than on specific stocks. The value of index calls increase as the index increases, and the value of index puts increases as the underlying index decreases.
The primary difference is in an index option they are cash settled.
3. Answer the following questions about option characteristics:
a. When do options expire? (Go to www.cboe.com and download the expiry calendar for options in the current year).
7. a. all options have standardized expiration dates. For most options this is the Saturday following the third Friday of certain designated months.
b. What are the striking price increments of options?
$2.50 or $5.00
c. What is the standard size for stock option contracts?
the standardized size for stock option contracts is 100 shares
d. What is the price of the option called?
The premium
e. What is fungibility? Why is it important?
For a given company all options of the same type with the same expiration and striking price are identical. It is important to the option writer. You can buy an identical option to get you out of the market.
f. Where to options come from?
The OCC Options Clearing Corporation.
they get created as needed , their has to be an interest.
Relate the opening and closing transactions to buying an option and writing an option.
Opening transactions are buying or selling options Closing transaction is when that position is closed out with a second trade.
What are the three roles of the Option Clearing Corporation?
Act as a guarantor of all option trades,
regulate the trading activity of members,
publish a booklet entitled Characteristics and risks of standardized options
What advantages do options have to offer in terms of the following?
a. Risk and return?
a.
b. Market Information?
b.
c. portfolio risk management?
c. Are used as risk management tools. They are more convenient to use than wholesale purchases or sales of shares of stock each time an adjustment is necessary
d. risk Transfer?
Risk can be transferred to another market participant who is willing to bear it.
e. Financial Leverage?
buying an option can be less expensive than buying an actual stock.
F. Income generation?
adjusts risks and alters income streams
On what exchanges are options traded?
CBOE & AMEX ISE, Philly, PSE
What are over-the-counter options?
Non regulated private party option arrangement
What is the purpose of OTC options?
To get non standardized option with characteristics that are currently not available
What are the potential problems associated with OTC options?
They are subject to counter party risk , which is one side being unable to perform if the option is exercised
List and briefly discuss at least three exotic options (page 22 of text).
As-you-like-it-option – an option in which the owner can decide, by certain date, to declare it a put or a call. Average price option – an option whose payoff depends on the average price of the underlying asset over the life of the option. Compound option – an option on an option
What is a LEAP, its characteristics, and its advantages?
Long-Term Equity Anticipation Security, they are similar to ordinary options except they are a longer term,
What is a FLEX option, its characteristics, and its advantages?
A flex option is fundamentally different from an ordinary listed option in that the terms of the option are flexible, the have the advantage of flexibility without the risk of an over the counter option.
What is the bid price?
Highest price anyone is willing to pay for an option
What is the ask price?
Lowest price at which anyone is willing to sell.
What is the difference between a market order and a limit order?
A market order expresses a wish to buy or sell immediately at the current price. A Limit Order specifies a particular price beyond which no trade is desired.
What is a day order versus GTC?
A day order is a Limit order that expires at the end of the day. GTC is a limit order that is Good Til Cancelled.
What is the difference between a specialist system and a Market maker system?
A specialist system is a trading floor system where there is a single individual through whom all orders to buy or sell a particular security must pass
The specialists job is to maintain a fair and orderly market.
Under a market maker system the specialist’s activities are split among three 3 groups , market makers, floor brokers, and the order book official. Market makers compete against each other for the publics business
What are floor brokers and an Order Book Officials?
Order book officials have many duties but one is to make sure that small orders to buy or sell are not ignored, and in fact get priority. Floor Brokers represent the public.
What is the intrinsic value of an option?
The value that an option is immediately worth. A call option intrinsic value is equal to stock price minus the striking price.
A put option intrinsic value is worth the strike price minus the stock price
What is the time value of an option?
The time value of an option is equal to the premium minus the intrinsic value
How are these mathematically related to the option premium?
Out of the money- an option with no intrinsic value.
In the money- option has intrinsic value.
At the money- the options strike price is exactly equal to the price of the underlying security.
Near the money- options that are almost At the money
What is “Strike Price?”
The agreed upon price for the underlying asset
What is the “Expiration?”
The last day of an option
What is the “Volume?”
The quantity traded during a given period of time
What is “Last?”
Bid price if no volume
What is “Open Interest?”
How many options exist at a particular point in time.
What is the relationship between the following?
Strike price of a call option and the option premium?
as the strike price goes down the option premium goes up
What is the relationship between the following?
Strike price of a put option and the option premium?
as the strike price increases the premium increases
What is the relationship between the following?
Time to expiry of a call option and the option premium?
the longer the time period the more its worth
What is the relationship between the following?
Time to expiry of a put option and the option premium?
the longer the time period the more its worth
Suppose you decide to exercise an option. What are the exercise procedures?
1. notify your broker
2. broker notifies OCC
a. who selects a contra party
b. anonymous
3. buy the stock and pay for it.
What is the P/L formula for writing a option (call or put)?
o= - (s-k) + premium

s=stock price
k=strike price
What is the P/L formula for buying a option (call or put)?
o= (s-k) - premium
how do you calculate the breakeven point?
solve for s in the formula
Buying or writing a put have limited profit and limited loss? How do you solve for that?
you use zero for the stock price and solve the equation.