4) Derivatives Flashcards
What is a Derivative
A contract whose value depends on the values of other underlying variables or assets
What is an Option
A financial contract that provides the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific time frame
What is an Option Holder and Option Writer
Option Holder - (buyer) is the one that is able to make a decision – to exercise or not, to buy or not, to sell or not – and they pay the option seller a fee for the privilege
Option Writer - (seller) has a decision forced upon them at some future
Why is an Option’s value positive
Because the option holder (buyer) is the one that is able to make a decision, and as that usually includes doing nothing, the value of an option is always at least zero
What is the formula for a European Call Option
What is the formula for a European Put Option
What is Exercise Price (Strike Price)
This pre-agreed price is written into the contract, and therefore the value of the option will depend on this price
What is the Underlying Share/Asset Price
The share price may also be called the underlying
share price or the underlying asset price
What is the Expiry Date/Maturity Date
The final termination date as specified in the contract
What is a Position
Denotes the amount of financial contracts held, and “closing out a position” means restore that number to zero
What is Profit
This is not to be confused with payoff which only considers what happens at expiry.
Profit must take account of the price paid on the day
the option was bought or sold
What is the formula for the profit of a European call option
What is the formula for the profit of a European put option
What is an investor’s expected profit for a European Call Option
