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143 Cards in this Set
- Front
- Back
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4.1
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4.1.
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option
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two party contract that conveys a right to the buyer and an obligation to the seller
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terms
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of an option contract this is standardized by the Options Clearing Corporation OCC, allows options to be traded easily on an exchange such as the CBOE Chicago board options exchange
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Calls and Puts
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What are the two types of options
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Classes of options
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All calls of one issuer, or all puts of one issuer are these
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Series
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All options of one issuer with the same class, exercise price, and expiration month are in the same ....
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American-style option
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when the call or put buyers can exercise a contract any time before expiration
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European style options
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Can be exercised only on the business day preceding expiration
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Equity options
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Most common type of options, includes 100 shares when issued
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Underlying instrument
Price Expiration |
What are the 3 specifications of every options contract?
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Underlying instrument
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anything with fluctuating value
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Price
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contract specifies this at which purchase or sale of the underlying security will occur
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Expiration
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a specified life cycle and expire on a specified date
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Derivative securities
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Options are called this because their value is derived from the value of the underlying instrument such as stock an index or a foreign currency
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Calls or puts
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An investor may either buy and go long or sell and go short with these options
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Long call
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buyer owns right to buy 100 shares of a specific stock at the strike price before the expiration if he chooses to exercise
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Short Call
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A seller has the obligation to sell 100 shares of a specified stock the strike price if the buyer exercises the contract
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long put
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buyer has right to sell 100 shares of a specified stock at the strike price before the expiration if he chooses to exercise
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short put
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seller has obligation to buy 100 shares of a specified stock at the stirke price if the buyer exercises the contract
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Exercised
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What the buyer of an option wants and he wins and seller loses when this happens
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Expire
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What the seller wants the contract to do. Seller wins because he gets to keep the premium. No purchase or sale of stock is required
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Buying calls, writing calls, buying puts, writing puts
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What are the 4 basic strategies available to options investors
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Long - investor has bought call and can go long
XYZ - 100 shares of XYZ stock Jan - Contract expires on the Saturday following the 3rd friday of January at 11:59 ET 60 The strike price of contract is 60 Call - type of option is a call 3 - The premium of the contract is $3 per share. Contracts are issued with 100 shares so the total premium is $300. Investor paid premium to buy the call |
What are the key features of the following call contract
Long XYZ Jan 60 call at 3 |
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Buyers of call want market price to rise. Investor who owns this call hopes that the market price will rise above 60. Can put the stock at price of 60 no matter what
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What does the buyer of the following call want the market price to do?
Long XYZ Jan 60 call at 3 |
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Short - investor has cold the call and has obligations to perform if the contract is exercised
Jan - contract expires on the Saturday following the 3rd friday of January at 11:59 pm ET. If expiration occurs, writer keeps the premium without any obligation Call - type of option is call and investor is obligated to sell the stock at 60 if exercised because he is short the call 3 - the premium of contract is $3 per share. Total premium is $300 |
What are the key points of the following call contract:
Short XYZ Jan 60 call at 3 |
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Writers of calls want the market price of the stock to fall or stay the same. Contract will not be exercised if the market price is at or below 60 at expiration and the writer keeps the premium of $300 with no obligation
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What do writers of calls want the market price of stock to do?
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Call buyer
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a bullish investor because he wants the market to rise. Call is exercised only if market price rises
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Call writer
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Bearish investor because he wants the market to fall. Contract is not exercised if the market price falls below the strike price
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Want the market price of the stock to fall. The investor who owns this put hopes that the market price will fall below 60. Can then sell at 60 even if market is below this number
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What does a buyer of put want the market price of underlying stock to do?
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Wants the market to stay the same or rise. If market price is at or above 60, investor keeps the premium of $300 with no obligation because contract will not be exercised
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What does a writer of puts want market price of underlying stock to do
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Put buyer
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Bearish investor who wants market to fall.
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Put writer
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Bullish investor wants market to rise so contract expires
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In-the-money call
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when the market price exceeds the strike price. Buyer will exercise the contract. Buyers want this, sellers do not
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At-the-money call
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when market price equals the strike price.Buyer will not exercise contract. Sellers want this, buyers do not
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Out-of-the-money call
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when market price is lower than the strike price. Buyer will not exercise contract. Sellers want this, buyers do not
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intrinsic value call
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in the money amount. When the market price is above the strike price. Found by subtracting strike price from market price. Buyers want this, sellers do not
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Parity
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Option is at this when the premium equals intrinsic value
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When ABC is at 62
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An ABC June 60 call trading at 2 will be at parity when?
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Breakeven point calls
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point at which investor netiher makes nor loses money. Found by adding the strike price and the premium
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In-the-money put
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when the market price is lower than strike price. Buyer will exercise the contract. Buyers want this, sellers do not
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At-the-money put
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when market price equals the strike price.Buyer will not exercise contract. Sellers want this, buyers do not
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Out-of-the-money put
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when market price is higher than the strike price. Buyer will not exercise contract. Sellers want this, buyers do not
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intrinsic value put
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in the money amount. When the market price is below the strike price. Found by subtracting strike price from market price. Buyers want this, sellers do not
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Breakeven point puts
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point at which investor netiher makes nor loses money. Found by subtracting the premium from the strike price
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Premium
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the price of an option contract, both bid and ask prices are quoted in cents
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Intrinsic value and time value
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An option's premium reflects what two types of values
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Time value
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the market's perceived worth of time remaining to expiration
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Ask or offer price
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What an option buyer will pay
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Bid price
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What the option seller will receive for premium
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Per share basis
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How option premiums are quoted. Calculated by multiplying by 100
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Volatility
Amount of intrinsic value Time remaining until expiration Interest rates |
The premium of an option is affected by what factors?
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Volatility
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the factor affecting premium with the greatest influence. Stock has potential to experience greater price movement with this
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Since Intrinsic value + time value = premium
Premium - intrinsic value = time value |
How to calculate time value for premium?
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As time passes, premium price goes down
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What is relationship between time and relationship
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4.2
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4.2
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bullish
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Call buyers are this
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Speculation
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most common reason for buying calls.
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Deferring a decision
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When an investor buys a call and lock in a purchase price until expiration date. WIll only lose premium
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Diversifying holdings
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Investor can buy calls on a variety of stocks and possibly profit from any rise in premium
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Protection of a short stock positon
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When investors use calls as an insurance policy against the stock rising in price
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Gain is unlimited and max loss is the premium paid
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What is the gain and loss of buying a call
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Maximum Gain is premium received
Max loss is unlimited |
What is the gain and loss for Call seller
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Exerices the option
Let the option expire Sell the option contract before the expiration date |
What are the 3 choices an owner of an option has before the expiration date?
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Closing the position
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the profit of loss based on the increase or decrease of the option's premium from the time the option was pruchased
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If buys an option will have a debit
If sells an option will have a credit |
What is relationship of profit to loss with buying and selling options
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Regular Way
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Exercises of listed equity options settle this way, or 3 business days from exercise date
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Debit | Credit
---------------------- 6.50 75 77 ----------------------- 81.50 77 ---------------------- 4.50 $450 loss |
If an investor buys 1 DWQ May 75 call at 6.50. Investor exercises call when stock is trading at 77 and immediately sells the stock what is the profit or loss?
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closing transaction
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The sale of the option before expiration
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4.3
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4.3
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The market will decline is the risk
Can inveset in Long put or sell Short Call |
What is the risk for a long stock position and what can he invest in to hedge it?
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That the market will rise
Can buy a long call or sell short put |
What is risk for short stock position and what can he invest to hedge it?
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Full = long put
Partial = Short call |
What gives full protection and partial protection for long stock position
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Full = long call
Partial = short put |
What gives full protection and partial protection for short stock position
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Covered call writing
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Selling calls when holding a long stock position
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Max gain is unlimited
If stock falls below 50, can exercise the put at 50. Loses $3 per share on the stock and has spent $2 per share for the put. Total loss = $500 Breakeven point is reached when stock rises by amount padi for the put. Or 53 + 2 = 55 |
If investor buys 100 shares of RST at 53 and buys and RST 50 put for 2 what is the max gain and total loss if stock falls below 50 and the break even point?
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Max gain is $400 ($200 for difference between stock price and call strike + Premium)
Max loss is $5,100 (price of stock bought minus premium) Break even point is reached when stock falls by amount of premium received (53-2=51) |
If investor buys 100 shares of RST at 53 and writes 1 RST 55 call for 2 what is max gain, max loss and break even point?
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Writing a covered put
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When a short stock investor sells puts for partial protection
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Max gain is $5,500 (if stock becomes worthless gets full price of selled stock - premium)
Max loss is $500 (If st ock rises above $60, investor will exercise call incuring a $200 loss on short sale and $300 paid for premium) Breakeven point is stock's sale price minum premium paid (58-2 or 55) |
An investor sells short 100 shares of RST at 58 and buys an RST 60 call for 3. What is max gain, loss and breakeven point
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Max gain is $250 (if stock declines to zero, put is exercised against him and must may $5,500 but receives $5,500 gain from the short sale and the $250 premium)
Max loss is unlimited Break even is 57.50 (original price sold + premium) |
A customer sells short 100 RST at 55 and writes an RST 55 put for 2.50 for partial protection what is max gain, loss, and break even point
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Cashless collar
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When an investor is long 100 shares and buys a put at 3 and sells a call for 3. He thus hedges his downside risk for no out of pocket cash
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Ratio call writing
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involves selling more calls than the long stock position covers
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4.4
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4.4
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Spread
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simultaneous purchase of one option and sale of another option of the same class
Call spread = long and short call Put spread = long and short put |
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Price or vertical spread, time or calendar spread, or diagonal spread
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What are the 3 types of spreadsd an invsetor can buy
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Price spread or vertical spread
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different strike prices but same expiration date
Ex: Long RST Nov 50 call for 7 Short RST Nov 60 call for 3 |
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Time spread or calendar spread or horizontal spread
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option contracts with different expiration dates but same strike prices
Ex Long RST Nov 60 call for 3 Short RST Jan 60 call for 5 |
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Diagonal spread
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one in which the options differ in both time and price
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Debit spread
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if the long option has a higher premium than the short option
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Credit spread
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if the short option has a higher premium than the long option
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Debit call spreads
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used by investors to reduce the cost of a long option position, potential reward of investor is reduced
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Max gain is $200 ($500 profit from selling at 60 is reduced by net premium of $300)
Max loss is the net premium = $300 Break even is between two strike prices, add net premium of 3 to the lower strike price = 58 |
Buy 1 RST Nov 55 call for 6
Sell 1 RST nov 60 call for 3 what is max gain, loss and break even? |
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Debit = widen = exercise
Debits spreads want the premium to widen |
What type of spread does the investor want to widen?
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Credit = narrow = expire
When premiums are narrow and expiration occurs |
When are credit spreads profitable?
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For CAL call spreads = Add net premium to lower strike price
For PSH put spreads: spubtract net premium from higher strike price |
How to find breakevens for call and put spreads?
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Max loss plus max gain must ALWAYS equal the difference in strike prices
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WHat is important tip for calculating max loss and gain?
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Gain = 6
Loss = 4 Breakeven = 54 |
Long XYZ 50 call at 9
Short XYZ 60 call at 5 What is max gain, loss and breakeven? |
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Credit call spreads
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created by investors to reduce risk of a short option position. investor is bearish
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Max gain is 7
Loss is 3 break even is - 52 |
Buy 1 RST Nov 55 call for 2
Sell 1 RST Nov 45 call for 9 what is max gain, loss, and break even ? |
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Debit put spread
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used by investors to reduce the cost of a long put position. Is bearish
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Credit put spread
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created by investors to reduce risk of a short put position
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Credit spread want to expire
Debit spread want to exercise |
What is relationship between credit/debit spread and exercising or expiring
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market attitude
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determined by the option that is more costly of the two
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Purchased the one with lower strke price (higher premium) so this is a debit and bullish
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What is market attitude for
Long 1 July 40 call Short 1 July 45 call |
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The option with lower strike price has higher premium
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What is relationship between call strike prices and premiums
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the option with higher strike price has higher premium
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What is relationship between put strike prices and premiums
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In put or call, if you are buying the lower strike price, you are a bull
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Fast way to determine whether spread is bullish or bearish?
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Straddle
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composed of a call and a put with the same strike price and expiration month, can be long or short
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Buyers want a large amount of movement in market
Sellers want a short amount of movement |
What are the objectives or buyers and sellers of straddles
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Long straddle
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Will expect substantial volatility in the stock's price but is uncertain of the direction the price will move
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Max gain is unlimited
Max loss is 7 Break even is 57 and 43 |
Buy 1 abc jan 50 call at 3
buy 1 abc jan 50 put at 4 what is max gain, loss and breakeven |
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Short straddle
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Investor expects the stock's price will not change or will change very little, collects 2 premiums
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Max gain is $900
Max loss is unlimited Breakeven is 54 and 36 |
Sell 1 ABC Jan 45 call at 4
Sell 1 ABC Jan 45 put at 5 what is max gain, loss and breakeven |
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Combination
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composed of a call and a put with different strike prices, expiration months, or both
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The call is in the money by 7 and the put is in the money by 3
Call was sold for 6 and bought back for 7 = a loss of $100 Put was sold for 7 and bought back at 3 a gain of $400 Therefore gain is $300 overall |
XYZ trades at 27, customer writes 1 XYZ jan 20 call at 6 and writes 1 xyz jan 30 put at 7. How much did customer make or lose?
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4.5
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4.5
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nonequity options
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function nearly the same as equity options, however because underlying instruments are non shares of stock, have different contract sizes and delivery exercise standards
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broad based indexes
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reflect movement of the entire market and include the S&P 100, S&P 500, and the Major Market Index (XMI)
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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 pharmaceuticals
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typically $100. Premium amount is multiplied by $100 to calculate the option's cost and strike price is multiplied by $100 to detmine total dolalr value of the index
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What is the multiplier of index options
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Purchases and sales of index options settle on the next business day
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What are the trading features of index options
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the exercise of an index option settles in cash rather than in delivery of a security and that cash must be delivered on the next business day
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what is the exercise features of an index option
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when index options are exercised, their settlement price is based on the closing value of the index on the day of exercise, not the value at the time of exercise
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what is the settlement price feature for index options
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Premium is $320
Breakeven is $463.20 Intrinsic value is $100 Time value is = $220 |
customer buys 1 OEX Jan 460 call at 3.20 when the OEX index is trading at 461
what is premium, breakeven, intrinsic value and time value |
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Exercising:
Cash: $1,200 (intrinsic value of option (472-460) Profit: $880 (cash received $1,200 minus the premium paid when bought $320) Closing Profit: $1,050, difference between the premium received on selling $1,370 and the premium paid to open the position ($320) |
customer buys 1 OEX Jan 460 call at 3.20 when the OEX index is trading at 461
one month later with the index at 472 and the Jan 460 call trading at 13.70, the customer exercises how much cash will customer receive and how much profit did he make? Instead of exercising the customer closes (sells), how much profit would customer make? |
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As long as there is time value in the option, the customer will always make more by closing an index option rather than by exercising
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Why would customer receive more for closing an index instead of exercising?
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portfolio insurance
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If portfolio manager holds diverse portfolio of equity and buys a put to offset loss if market value of stocks fall
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Sytematic or systemic risk
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the risk of a decline in the overall market
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Beta
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measure of the volatility of a stock or a portfolio related to the volatility of the market in general
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Because beta is 1.2, the portfolio is %20 more volatile
Customer needs 20% more protection, or 24 OEX 460 puts |
if client with $920,000 portfolio has a beta of 1.2, instead of purchasing 20 OEX 460 puts to hedge, how much stock should he purchase?
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For 1% beta, whatever market does, the profile will have same volatility
for 1.2%, it is 20% more volatile than the market therefore if market rose by 10%, portfolio would rise by 12% (20% more) |
If portfolio has beta of 1% what will happen? what about 1.2%
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Interest rate options
strike price of 35 would yield 3.5% |
yield based options that have a direct relationship to movement in interest rates. Based on yields of T-bills, T-notes, and T-bonds
Yield based option with strike price of 35 reflects what yield? |
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European style, exercised only on business day before expiration
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What style are yield based options
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Foreign currency options
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allow investors to speculate on the performance of currencies other than the US dollar
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Strike prices of most foreign currency options are quoted in US cents. Yen is an exception and is quoted in 1/100th of cent
Ex. Strike price of .85 = 85 cents Japanese yen strike price of 121 is = 1.21 US cents |
How is strike price quoted for foreign currency options
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take the premium amount x100
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How to calculate premiums of foreign exchange options?
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Currency options settle on the next business day
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when do foreign currency options settle
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European style only
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What are world currency options styles?
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If thinks foreign currency values will rise due to dollar falling, then should buy calls on Swiss franc
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If a US importer must pay for swiss chocolates in swiss francs within 3 months and is fearful the value of the dollar will fall. What should he do regarding foreign currency options?
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Importers should buy calls and exporters should buy puts to hedge
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What should importers and exporters do regarding foreign options?
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Because cannot buy options in US dollar, should buy call in Japanese yen.
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If a Japanese company exports stereos to the US and believes the US dollar will decline between now and delivery what should they do?
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4.6
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4.6
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listed options
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exchange traded options that have standardized strike prices and expiration dates
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Listed options transactions settle on the next business day
Stock delivered as a result of exercise is settles on a regular way basis (3 business days) |
How do options settle?
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