Derivatives Chapter 3 Spring 2007

Front 1

What is a important point on risk management?

Back 1

money spent on reducing risk is not wasted.

ex. ins. premium

Front 2

What is a long position in the security?

Back 2

Someone who owns shares of that stock

Front 3

What is the breakeven on a long Stock position?

Back 3

The purchase price, if the price remains unchanged for some time.

Front 4

Why would an investor want a protective put?

Back 4

They anticipate a decline in the stock price, but do not want to sell or cannot sell the long stock.

Front 5

What is a protective put?

Back 5

The simultaneous holding of a long stock position and a put option on that stock.

Front 6

Buying a ______ ____ is very similar to the outright purchase of a _____ option.

Back 6

protective put; call

Front 7

synthetic option

Back 7

a collection of financial instruments that are equivalent to an option position.

Front 8

A protective put is an example of a .....

Back 8

synthetic call

long stock + long Put=long call

Front 9

What is a short sale?

Back 9

the 1st transaction is the sale and the 2nd transaction is a purchase.
selling borrowed shares

Front 10

What is "covering the short position"?

Back 10

closing out a short position

Front 11

What is a difference between a long put and a short sale?

Back 11

in a long put the potential for unlimited losses is eliminated.
in buying a put the maximum loss is the premium.

Front 12

what is one way to hedge the risk on a short sale?

Back 12

add a long call position to the short stock position

Front 13

short stock + long call=

Back 13

long put

Front 14

What is a covered call?

Back 14

you are buying the underlying stock shares and selling call options against it.

Front 15

On a covered call what is the maximum loss?

Back 15

The stock price minus the option premium.

Front 16

Why might a investor use a covered call?

Back 16

To protect against a market downturn.
to generate income on a stock.

Front 17

What is a risk of a covered call?

Back 17

that the market price will rise and the stock will get called away.

Front 18

What is the better hedge against a market downturn a covered call or a put option?

Back 18

the put option.

Front 19

what is the premium on writing a option?

Back 19

compensation for bearing added risk or for forgoing future price appreciation.

Front 20

What are the tax implications on option premiums?

Back 20

If you buy an option and it expires worthless you have a capital loss.
If you write an option and it expires worthless you have a capital gain.

Front 21

If an option gets exercised, the option premium alters the purchase or sale price of the underlying stock.
Explain this....

Back 21

if you buy a call and exercise the premium is added to the stock price and the irs considers it the purchase price. If you write a call and its exercised the premium is added to the stock price and becomes the selling price.

Front 22

When is not a good time to write a covered call?

Back 22

when option premiums are very low.

Front 23

is it a good idea to write a long term option to generate income?

Back 23

no, it is better to write a series of short term.

Front 24

How do brokerage firms discourage individual/small investors from writing naked options?

Back 24

by enforcing certain minimum account balance requirements before permitting this type of speculative acivity.

Front 25

writing puts is similar to ....

Back 25

writing covered calls

Front 26

A naked put usually means....

Back 26

a short put by itself.

Front 27

A covered put usually means...

Back 27

the combination of a short put and a short stock position.

Front 28

What is a fiduciary put?

Back 28

writing a put option and simuiltaneosly deposit the strike price into a special escrow account.

Front 29

How do options create contingent liabilities on the balance sheet?

Back 29

When you write an option

Front 30

Long stock + short call= ___

this equation creates p/l diagram identical to....

Back 30

short put

covered call's are identical to short puts p/l diagrams.

Front 31

Why are covered calls written more often then short puts?

Back 31

ignorance about the merits of this strategy.

Front 32

What is put overwriting?

Back 32

involves owning shares of stock and simultaneously writing a put option against these shares.

Front 33

What type of strategy is put overwriting?

Back 33

it is a bullish strategy.

Front 34

What is the largest possible gain when an investor writes an option?

Back 34

the option premium.

Front 35

What is the P/l equation on a put overwrite?

Back 35

=(current price -purchase stock price) +option premium -(put strike price -current price)

Front 36

What type of investor is put overwriting appropriate for?

Back 36

a portfolio manager who needs to generate additional income but does not want to write calls for fear of opportunity losses in a bull market.

Front 37

What is a protective put with a seasoned position?

Back 37

You bought a stock and it has appreciated in value and you write a protective put to protect it against a decline in value.

Front 38

What is a protective put with a seasoned position p/l equation?

Back 38

=(spot price -stock price)+ (put strike - spot) -prem

Front 39

Writing a covered call against an existing stock position. How is this diff from a covered call purchased with a stock.

Back 39

the p/l shifts upward by the diff from the orig price and the current price.

Front 40

why write deep-in-the-money calls?

Back 40

you want to sell the shares but generate extra income and don't need the money from the sale of the shares right away.

Front 41

What is a risk with trying to improve on the market with a deep in the money call?

Back 41

that the stock price drops while your waiting for the option to expire.

Front 42

Why write a deep in the money put?

Back 42

you wish to buy the stock but not outright, so you write a deep in the money put and make the income from the premium and when the stock is exercised you buy the shares.