20: Options Market Flashcards
Call Option Definition
The right to buy an asset at a specified exercise price on or before a specified expiration date.
Premium Definition
The purchase price of an option.
Put Option Definition
The right to sell an asset at a specified exercise price on or before a specified expiration date.
In the Money Definition
An option whose exercise would result in profit.
Out of the Money Definition
An option whose exercise would result in losses.
At the Money Definition
An option where the exercise price is equal to the asset price.
American Option Definition
An option that can be exercised on or before the expiration date.
European Option Definition
An option that can only be exercised on the expiration date.
Protective Put Definition
A two-part investment consisting of:
1. The purchase of a stock, and,
2. Buying a put option that guarantees minimum profit equal to the put’s exercise price.
Covered Call Definition
A two-part investment consisting of:
1. The purchase of a stock, and,
2. Selling/writing a call option on that stock.
Straddle Definition
An investment strategy that is a combination of buying a put option and a call option on the same asset, each with the same exercise price and expiration date.
The goal is to profit from expected volatility.
Money Spread Definition
An investment strategy that involves buying 2+ call options or put options with the same expiration date but different exercise prices.
Time Spread Definition
An investment strategy that involves buying 2+ call options or put options with the same exercise price but different expiration dates.
Collar Definition
An options strategy that brackets the value of a portfolio between two bounds.
Put-Call Parity Theorem
Requires that the difference between the price of a call and the price of a put be equal to the difference between the price of a stock and the present value of the exercise price.
C - P = S - PV(X)
If the equality doesn’t hold there is opportunity for arbitrage.
Warrants Definition
Options issued by a firm to purchase shares of that firm’s stock.
What is the difference between American and European options?
American options can be exercised up to and on the expiration date, whereas European options can only be exercised on the expiration date.
Are there more American or European options traded?
American
All else equal, will an American or European option that pays dividends have a higher premium?
American
Give examples of what options can be traded on.
Stocks, stock indexes, foreign currencies, fixed-income securities, and several futures contracts.
How can options be used to an investor’s advantage?
Increase exposure to fluctuations in asset prices or provide insurance against volatility in asset prices.
In what situation is a covered call used?
When the investor sells a call option on a stock they already own to generate income.
In what situation is a protective put used?
To hedge risk when first acquiring shares of a stock.
In what situation is a straddle used?
To bet on or financially engineer expected large amounts of volatility.
Could be a long put and a long call.
Name each of the variables in the equation for Put-Call Parity Theorem
P = C - S + PV(X) + PV(d)
P = put price
C = call price
S = price of the stock at time T=0
PV(X) = the present value of the exercise price
PV(d) = the present value of any dividends to be paid before the expiration date
What does the payoff of a straddle look like?
What is a long call?
The position in which you own the call option.
What is a long put?
The position in which you own the put option.
What is a short call?
The position in which you sell or write the call option.
What is a short put?
The position in which you sell or write the put option.
All else equal, will an American or European option that does not pay dividends be priced higher?
They will be priced equally.
