6 - Option Strategies and Risk Management Flashcards
what does a positive N imply, what does a negative N imply?
postive N - go long
negative N - go short
what does capital pi stand for?
profit
what does Nc, Np and Ns stand for?
number of calls, puts or stocks
what is the profit equation for buying a call? for selling a call?
cap pi = Nc (max(0,St-X) - C)
cap pi = -Nc (max(0,St-X) + C)
what is the profit equation for buying a put? for selling a put?
cap pi = Np (max(0,X-St) - P)
cap pi = -Np (max(0,X-St) + P)
in regards to premium for a call or put, when do you receive the premium and when do you pay the premium?
buy - pay premium (hence -C/-P)
sell - receive premium (+C/+P)
what is the profit equation for a stock?
cap pi = Ns (St-So)
cap pi = Ns (-St+So)
when you buy a stock what is the maximum profit? loss?
profit = infinite loss = initial payment i.e. So
when you sell a stock what is the maximum profit? loss?
profit = initial payment received i.e. So loss = - infinite
when you buy a call what is the maximum profit? loss?
profit = infinite loss = initial payment i.e. C premium paid
when you sell a call what is the maximum profit? loss?
profit = initial payment received i.e. C premium received loss = - infinite
which positions are considered bullish?
buy stock
buy call
sell put
which positions are considered bearish?
short selling stock
short selling call
buying put
what is the position for a covered call, what does it aim to do?
Position: for every call you short you buy one stock
Aims: to reduce the loss of writing(short selling) a call
what is the position for a protective put, what does it aim to do?
Position: for every stock you buy you buy a put
Aims: to reduce your potential loss when you buy a stock
why would you want to create a synthetic put or call?
because they may not be traded on the market or the premium may be unacceptable.
what is the put call party formula?
P + S = C + PV(X)
what is a money spread? what are examples of money spreads?
taking an options and writing an option at the same time with different exercise prices.
ie bull or bear spread, collars, butterfly spread
what is a time (calendar) spread? what is this technique based on?
taking an options and writing an option at the same time with different expiration date but same strike.
volatility
why do investors use option spreads? 2
- reduce risk
- low costs of long positions
what is a bull spread? position and aim
position: buy call with X1 and sell call with X2 where X1
what is the profit formula for a bull spread?
cap pi = N1 (max(0, St-X1) - C1) + N2(max(0, St-X2) - C2)
N2 is negative and C1>C2
when does a bull spread breakeven?
when St = X1 + C1 + C2
what is a bull spread using calls? position and aim
position: sell a call with X1 and buy a call with X2 where X1
what is the profit formula for a bear spread? using calls
cap pi = N1(max (0, St-X1) - C1) + N2(max(0, St-X2) - C2)
the same as bull this time N1 is negative and C1>C2 (make money)
what is a bull spread using puts? position and aim
position: sell a put with X1 and buy a put with X2 where X1
what is the profit formula for a bear spread? using puts
cap pi = N1(max (X1-St) - P1) + N2 (max(0, X2-St) - P2)
where N1 is neg and put bought is more expensive than Put sold (cost)
when does a bear spread using puts breakeven?
St = X2 + P1 - P2
what are collars similar to? whats the key difference?
bull spreads, the earn more, earn interest on X1
what is the position and aim of a collar?
position: buy stock and buy put with X1, see call with X2
aim: no initial outlay for options, call premium set so that it offsets the put premium
what is the position and aim of a butterfly spread? position and aim
position: buy call with X1, buy call with X3, sell 2 calls with X2
aim: speculate that large stock price movements are unlikely.
what is the profit equation for a butterfly spread??
cap pi = (max (0, St-X1) - C1) - (2max(0, St- X2) + 2C2) + (max(0,St-X3) - C3)
what is a straddle? position and aim?
position: for every call you long you long a put with the same exercise price.
aim: you know the stock price is going to move but you don’t know in which direction. volatility if greater than what the market is pricing it for
what is a short straddle? why is it more risky?
position: for every call you short you short a put with the same exercise price.
unlimited loss potential, would only do this if you believed volatility is less than perceived
what is a strip? position and aim?
position: long 2 puts, long 1 call
aim: double up bet that stock will decrease
what is a strap? position and aim?
position: long 2 calls, long 1 put
aim: double up bet that stock will increase
