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9 Cards in this Set

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  • Back

What does it mean to write a put naked?

writing a put without an offsetting short position in the stock for hedging purposes

What is a protective put? When is it useful? Draw the payoff structure

Investing in a stock and purchasing a put option on the stock.



When you want to invest in a stock, but are unwilling to bear potential losses beyond some given level.

What is a covered call? When is it useful? Draw the payoff structure

A covered call position is the purchase of a share of stock with a simultaneous write of a call option on that stock.



If you anyways plan to sell the stock at a certain price you might as well write a call on it and collect the premium.

What is a naked call?

writing a call without an offsetting stock position

What is a straddle? When do you want to use a straddle position? Draw the payoff structure.

Buying both a call and a put on a stock, each with the same exercise price, X, and the same expiration date, T.



Useful when you believe a stock will move a lot in price but are uncertain about the direction of the move. Conversely, investors writing straddle positions think the stock is less volatile.

What is a spread? When is a spread useful? Draw the payoff structure.

A combination of two or more call or puts on the same stock with differing exercise prices (money spread) or times to maturity (time spread). Some options are bought, whereas others are written.



Motivation for a bullish spread, i.e. spread with calls, might be that an investor believes one option is overpriced relative to another.

What is a collar?

A strategy that brackets the value of a portfolio between two bounds. Buying a protective put and writing a call.

What is the put-call parity theorem?

A protective put and a portfolio of a call option and a zero-coupon bond produces the same payoff. Therefore the two portfolios must cost the same to establish, if not there is an arbitrage opportunity.



P = C - S0 + PV(X) + PV(dividends)

What are the assumptions behind Black-Scholes?

1. Both risk-free interest rate and stock price volatility are constant over the life of the option


2. The stock pay no dividends until after the option expiration date


3. Stock prices are continous, meaning that sudden extreme jumps such as those in the aftermath of an announcement of a takeover attempt are ruled out.