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28 Cards in this Set

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options contract
- two party contract that conveys a right to the buyer and an obligation to the seller
- the terms of option contracts are standardized by the options clearing corporation
- two types of options are calls and puts
- each contract includes 100 shares when issued
two parties in a options contract
buyer - long - holder - owner - pays premium to seller. there is a debit to the account of the buyer when premium is paid - buyer opens his position with a debit to his account - has rights to exercise (buy or sell stock)
- seller - short - writer - receives premium from buyer - there is a credit to the accont - seller opens his position with a credit to his account - has obligations at exercise (must buy or sell as required by contract)
calls
short call - seller has the obligation to sell 100 shares at strike price if the buyer exercises the contract - call seller is bearish - want market price to go down
- long call - buyer owns the right to buy 100 shares of stock at the strike price before expiration - call buyer is bullish - wants market price to go up
puts
long put - buyer owns the right to sell 100 shares of stock at strike price before expiration - buyer wants contract to be exercised
- short put - seller has obligation to buy 100 shares os stock at strike price if buyer exercises the contract - seller wants contract to expire - he would get to keep the premium (no purchase or sale of stock required)
long xyz jan 60 call at 3
Long - investor has bought the call and has the right to exercise the contract
xyz - contract includes 100 shares of xyz stock
jan - contract expires on the saturday following the third friday of january at 11:59
60 - strike price
call - type of option - investor has the right to buy the stock at 60 since he is long the call
4 - premium of contract is $3 per share so total premium is $300 - what investor paid to buy the call
in the money
- for a call it is when the market price exceeds the strike price - buyers will exercise calls that are in the money at expirations
- for puts in the money is when the market price is lower than the strike price
at the money
- when the market price equals the strike price - buyer will not exercise contracts that are at the money for puts or calls
out of the money
- for calls when the market price is lower than the strike price - buyer will not exercise
- for puts when market price is higher than the strike price - buyer will not exercise
intrinsic value
- for calls - in the money amount - subtract strike price from market price
- for puts - in the money amount - subtract market price from strike price
- time value is the premium minus the intrinsic value - the further to expiration the greater the time value
- a good way to remember is put down - a put has intrinsic value when the market price is below the strike price whether long or short
breakeven point
- for calls - add the strike price and the premium - for buyer the contract is profitable above the breakeven - for seller, contract is profitable below the breakeven
- for puts - subtract premium from strike price - for buyer it is profitable below break even - seller is better above breakeven
attractions to calls and puts
call buyers - speculation of upward price - deferring a decision (can lock in a price) - diversifying holdings - investor can buy calls on a variety of stocks - maximum gain is unlimited for call owners - maximum loss is the premium
- put sellers - buy stock below current price - maximum gain is the premium - maximum loss is the strike price minus the premium
choices at expiration
- exercise the option - the holder of a call will buy the stock at the strike price - the holder of a put will sell the stock at the strike price
- let the option expire - holder of call allows the option to expire if market price is equal or less than strike - holder of a put allows the option expire if mp is greater or equal to strike price
- sell option before expiration - no sale of stock
spread
- simultaneous purchase of one option and sale of another option of the same class
- call spread is a long call and a short call - the more expensive contract has lower strike price
- put spread it a long put and a short put - the more expensive contract has the higher strike price
types of spreads
- price spread or vertical spread - different strike prices but same expiration date
- time or calendar spread - horizontal spread - option contracts with different expiration dates but the same strike prices
- diagonal spread - options differ in both time and price
- spreads are categorized as either debit spreads or credit spreads - debt if long option has higher premium than short option
debit and credit spreads
- debit spreads are profitable if widening of premiums or exercise occurs or both options are exercised - net debit = maximum loss and max gain is the strike price difference minus net debit
- credit spreads are profitable if difference in premiums narrow or expiration occurs - sellers want expiration - net credit = maximum gain and maximum loss is the strike price difference minus the net credit/max gain
- the break even for spreads is as fallows: for call spreads add net premium to lower SP (CAL), for puts subtract net premium from higher SP (PSH)
straddle
- composed of a call and a put with the same strike price and expiration months and stock
- if you sell a straddle you are preparing for stability
- if you buy a straddle you are preparing for volatility
- break even = SP + total premiums and SP - total premiums
long straddle
- you gain when you are outside the break even point - gain is unlimited
- you lose when SP remains in between break even points - maximum loss is the total premiums
short straddle
- you gain when sp remains in between break even points - maximum gain is total premium
- you lose when sp goes outside break even points - maximum loss is unlimited
non equity options
- Index Options
- Yield based debt options
- foreign currency options
index options
- reflect movement of the entire market
- include S&P (OEX) and AMEX (XMI)
- typically multipliers of $100
- trades settle on next business day whereas equity options trade regular way
- on exercise the seller delivers cash equal to intrinsic value
- intrinsic value is determined by the index value at close on exercise day
- if someone has a 276,000 portfolio and OEX is @230 how many puts should he buy? 276000/23,000 = 12
yield based debt options (interest rate options)
- value is based on yields of t-bills, t-notes, and t-bonds
- yield based option with a strike price of 35 reflects yield of 3.5% YTM
- 1 basis point change equals $10
foreign currency options
- quotes - take left 2 decimal points
- size = # of units per contract
- quote X size equals price
- exporters buy puts and importers buy calls - EPIC
trading roles on the CBOE
- order book official - OBO - not executed immediately - usually exchange employee - maintains public orders - sometimes given by floor broker
- floor broker - execute orders for BD and its customers - firm representative
- market makers or floor traders - trade for their own accounts
OCC
- options clearing corp
- guarantees all options contracts
- settlement - next business day when options trade
- exercise - long customer exercises right and tells BD - BD then contacts OCC - OCC assigns to short BD at random and short BD allocates to short customer - they pick seller either randomly, by FIFO or by any other fair method - then stock is delivered t + 3 business days
What are the closing times
- trading stops on 3rd friday of the month at 4:00
- exercise stops on 3rd friday at 5:30
- expiration occurs on saturday after 3rd friday at 11:59
- all at ET time
Options disclosure statement
- must be sent to customer at or before account approval and before first trade can be made
- it defines risks and charistics of options
option agreement
- not opened until signed
- customer attests to financial information, investment experience, and statement of understanding
- must be signed and returned by customer within 15 days after account approval
- if late, can only close transactions not open
CROP
- any communication with the public must have the CROP approval for advertising, educational material, and sale literature