1 - Intro to Options Market

Question 1

who is the biggest user of options? what are three further users?

Answer 1

Retail markets

• individuals
• private businesses
• financial institutions

Question 2

Why do people use options? (4 types)

Answer 2

risk management

• hedging
• speculation
• short selling
• leveraging opportunities

Question 3

What are the features of an index option?

Answer 3

• option on market index
• cash settled on exercise
• used for hedging/speculating market trends

Question 4

what are the features of an equity/share option?

Answer 4

• option on specific securities
• shared exchanged on exercise
• used for hedging/speculating individual stocks

Question 5

What’s the difference between a call and a put option?

Answer 5

Call
-right to buy

Put
-right to sell

Question 6

Whats the difference between and American and a European option?

Answer 6

American
- right to buy/sell on or before expiration

European
- right to buy/sell on expiration date

Question 7

What is the risk premium?

Answer 7

The cost to buy an option

Question 8

what are three features of over-the-counter options?

Answer 8

• customised
• private transactions
• unregulated

Question 9

what is meant by long and short positions?

Answer 9

long- you are the taker

short- you are the writer

Question 10

when is an option at the money?

Answer 10

S=X

Question 11

when is a call option in the money?

a put?

Answer 11

S>X

S

Question 12

when is a call option out of the money?

a put?

Answer 12

SX

Question 13

What is the intrinsic value?

Answer 13

the theoretical value of the option if the maturity date were today

Question 14

how must a writer of an option ensure that they can deliver if exercised against?

Answer 14

• cover themselves (insurance)

- maintain margin to offset uncovered position

Question 15

When does the writer pay taxes?

Answer 15

when they receive the premium

Question 16

When does a taker pay tax?

Answer 16

• bought as a trading asset - losses deductible during yr they occur
• bought as a hedge - option fee can be deductible (purchased on revenue account)

Question 17

Are ASX traded options American or European?

Answer 17

European

Question 18

What are the main benefits of an index option? 3

Answer 18

• leverage (greater exposure to ASX)
• low trading costs
• exposed only to market risk

Question 19

What benefit does a share option have over an index option?

Answer 19

If you sell the share option you can protect yourself from a decrease in the underlying asset.

Question 20

What is the difference in a short call and a long put position?

Answer 20

shorting is selling something you don’t own - you have the obligation to deliver the goods at pre-determined price if exercised against
long put gives you the right but not the obligation to sell at a pre-determined price on the exercise date.
writing call = premium up front
long put = paying premium up front

Question 21

Why is an efficient market important to derivatives?

Answer 21

derivatives derive value from underlying asset - therefore its important that the underlying asset is correctly priced so that we can correctly value derivatives

Question 22

What are four transaction costs of trading options?

Answer 22

• brokerage fees/comissions
• bid-ask spread
• admin fees (clearing house)
• exchange fee (ASX fee)

Question 23

how is the tax treatment for the premium different for the writer and the taker of an option?

Answer 23

writer- receives premium - tax assessable

taker - pays premium - tax deductible