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69 Cards in this Set
- Front
- Back
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Option
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a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date Is a security binding contract with strictly defined terms and properties |
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Call
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gives the holder the right to buy an asset at a certain price within a specific period of time similar to having a long position on a stock hope that the stock will increase substantially before the option expires |
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Put
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gives the holder the right to sell an asset at a certain price within a specific period of time. similar to having a short position on a stock hope that the price of the stock will fall before the option expires. |
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Participants in the Options Market Four Types of Participants in option markets |
1. Buyers of calls
2. Sellers of calls 3. Buyers of puts 4. Sellers of puts |
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Call holders and put holders (buyers)
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are not obligated to buy or sell They have the choice to exercise their rights if they choose. |
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Call writers and put writers (sellers)
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are obligated to buy or sell may be required to make good on a promise to buy or sell. |
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Strike Price aka Exercise price |
price at which a specific derivative contract can be exercised
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Exercise
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to put into effect the right specified in a contract
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Expiration Date
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the last day that a is valid normally the third Friday of the contract month, which is the month when the contract expires |
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Chicago Board Options Exchange - CBOE
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world's largest options market trades in equity and index options and interest rates. |
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American style
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options can be exercised at any time up to the expiration date,
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European style
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Can be exercised only on the business day preceding expiration
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In The Money calls
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An option the will produce a profit if it is exercised The market price exceeds the strike price buyer will exercise the contract CMV>SP |
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Intrinsic Value Calls
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The market value is above the strike price Strike price - market price Never a negative value - deplete to zero Intrinsic value at expiration will be exercise CALLUP |
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Out of the money call
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the price is lower then the strike price buyer will not exercise seller keeps the premium CMV |
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At the money call
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market price equals the strike price buyer will not exercise the contract seller will keep the premium with being obligated to honor the contract CMV=SP |
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Parity Calls
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premium equal intrinsic vale
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Break even point Call
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point at which the investor neither makes nor lose money Contract is profitable above the break even CMV+PERMIUM |
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In the money puts
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The market price is lower then the strike price CMV |
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At the money puts
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market price is equal to the strike price CMV=SP |
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out of the money puts
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market price is higher then the strike price CMV>SP |
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Intrinsic Value Puts
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when the market value price is below the strike price market price - strike price Intrinsic value at expiration will be exercise |
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Break Even Puts
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point at which the investor neither makes nor lose money Contract is profitable is below the breakeven CMV-PERMIUM |
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Chicago Mercantile Exchange (CME),
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second-largest exchange for futures and options on futures and the largest in the U.S. Trading involves mostly futures on interest rates, currency, equities, stock indices and a small amount on agricultural products
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Long call Buy = Hold |
Debit - Protection MG = Unlimited ML = Perm BE = Strike Price + Premium Right to buy Bullish Arrow Up Left Side |
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Short Call Sell = Write |
Credit - Income MG = Premium ML = Unlimited BE = Strike price + Premium Obligation to Sell Bearish Arrow Down Right Side |
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Long Put Buy = Hold |
Debit - Protection MG = Strike Price - Premium ML = Premium BE = Strike price - Premium Right to sell Bearish Arrow Down Right Side |
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Short Put Sell = Write |
Credit - Income MG = Premium ML = Strike - Price BE = Strike Price - Premium Bullish Left Side Arrow Up |
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Short Stack
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Long Call - Full protection Short Put - Partial protection |
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Long Stack
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Long Put - Full Protection Short Call - Short Put |
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Factors Affecting Premium
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Option is affected by the following factors include the following Volatility - with the greatest influence Amount of Intrinsic value time remaining until expiration interest rates |
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Buying calls
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Bullish on underlying Stock investor can profit from and increase in a stock while investing a small amount of money use calls to protect a sort stock position option act as an insurance policy pay premium |
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Writing calls
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bearish or neutral on the price of the underlying stock investor believes the stock will decline or stay the same Investor earn the premium Right - income |
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protection of a short stock
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can use calls to protect a short stock position option acts as an insurance policy against the stock rising in price |
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protection of a long stock
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provides limited downside protection to the extent of the premium received |
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uncovered call or naked call Gain |
Writer max gain premium is received call is uncovered investor does not own the underlying stock Max Gain is earned when the stock price is at or below the exercise price at expiration |
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Uncovered call or naked call Loss |
Writer max loss is unlimited the writer could be forced to buy the stock at the potentially unlimited price option is exercised against him for the delivery at the strike price |
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Buying Puts
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Bearish on the underlying stock investor can profit from the decrease in a stock price small amount of money needed to be invested investor purchase the puts buy a out to lock in the sale price use to protect a long stock |
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Writing Puts
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Bullish or neutral on the price of the underlying stock investor believes the price will go up or stay the same additional income can be earned by keeping the premium |
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Closing transaction
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sale of an option
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Opening and Closing Transactions
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Long Buy Contract Sell Contract Short Sell Contract Buy Contract |
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Hedge
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reduce the risk of adverse price movements in an asset
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Radio call writing
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selling more calls then long stock covers strategy generates additional premium income unlimited risk because of the short uncovered calls |
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covered call writing
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partial protection that generates income and reduces the stock up
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Spread
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consisting of the purchase of an option and the sale of another option on the same underlying security with a different strike price or expiration date
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Hedging
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use to help protect against the risk of the position
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Price spread aka Vertical spread |
has a different strike price but the expiration date vertical Spread Strike price on options reports are reported vertically Example Long RST NOV 50 CALL FOR 7 SHORT RST NOV 60 CALL FOR 3 |
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Horizontal Spread aka Calendar Spread |
Different expiration dates but the same strike price Example Long RST NOV 60 Call for 3 Short RST JAN 60 call for 5 |
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Debit Call Spread
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investor to reduce the cost of a long option position bullish |
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Debit Spread
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Long option has a higher premium then the short option
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Credit Spread
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Short option has a higher premium than the long option
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Credit Call Spread
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bearish reduce the risk of a short option position |
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Long Straddle
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expects a substantial volatility in the stock price but is uncertain of the direction that it will move MG = Unlimited ML = 700 Breakeven = 57, 43 Buy 1ABC Jan 50 call @ 3 Buy 1ABC Jan 50 put @4 |
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Short Straddle
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Writer expect that the stock price will not change or will change very little MG = 900 ML = Unlimited BE = 54, 36 |
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Combination
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similar to a straddle Cheaper to establish than long straddle |
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Broad Based Option
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reflect movement of the entire market and include the S&P 100 (OEX), S&P 500, and the Major Market Index |
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Narrow based Indexes
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Track the movement of market segments in a specific industry, such as technology or pharmaceutical |
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VIX (volatility market index)
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over the next 30 days aka fear gauge |
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index option protect against
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systemic or systemic rick
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Beta
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Leaps
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expiration dates that are longer than one year LEAPs allow long-term investors to gain exposure to a prolonged trend in a given security without having to roll several short-term contracts together |
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Automatic exercise
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Contracts that as in the money by at least .01 |
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Designated Primary market Maker (DPM)
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Responsible for maintaining a two sided market for a specific product on the CBOE Fair and orderly market performs the role of market maker and or floor broker |
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Market Makers
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must buy and sell option in which they maintain on orderly market |
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Floor Brokers
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Firms representatives on the floor of the exchange execute orders on behalf of the firm and its customers |
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option Clearing Corporation ( OCC )
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owned by the exchanges that trade options designate the strike price and expiration month for a new contract assign exercise notices on a random basis FIFO must be provided at or before the account approval |
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option agreement
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if not returned before 15 days client cannot open a new option position only closing transactions are allowed if the option agreement is not returned as required |
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Possible tax Consequences of option Strategies
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long option that has been exercised results in a capital gain or loss. One that has expired without exercise results in a capital loss of the premium. short option that has been exercised also results in a capital gain or loss One that has expired without exercise results in a capital gain of the premium |
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Which of the following investors will sell stock if an option is exercised
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An owner of a put and writer of a call will sell stock if an option is exercised Call buyers have the right to buy, and call writers are obligated to sell; put buyers have the right to sell, and put writers are obligated to buy. |
