6 - Option Strategies and Risk Management

Question 1

what does a positive N imply, what does a negative N imply?

Answer 1

postive N - go long

negative N - go short

Question 2

what does capital pi stand for?

Answer 2

profit

Question 3

what does Nc, Np and Ns stand for?

Answer 3

number of calls, puts or stocks

Question 4

what is the profit equation for buying a call? for selling a call?

Answer 4

cap pi = Nc (max(0,St-X) - C)

cap pi = -Nc (max(0,St-X) + C)

Question 5

what is the profit equation for buying a put? for selling a put?

Answer 5

cap pi = Np (max(0,X-St) - P)

cap pi = -Np (max(0,X-St) + P)

Question 6

in regards to premium for a call or put, when do you receive the premium and when do you pay the premium?

Answer 6

buy - pay premium (hence -C/-P)

sell - receive premium (+C/+P)

Question 7

what is the profit equation for a stock?

Answer 7

cap pi = Ns (St-So)

cap pi = Ns (-St+So)

Question 8

when you buy a stock what is the maximum profit? loss?

Answer 8

profit = infinite
loss = initial payment i.e. So

Question 9

when you sell a stock what is the maximum profit? loss?

Answer 9

profit = initial payment received i.e. So
loss = - infinite

Question 10

when you buy a call what is the maximum profit? loss?

Answer 10

profit = infinite
loss = initial payment i.e. C premium paid

Question 11

when you sell a call what is the maximum profit? loss?

Answer 11

profit = initial payment received i.e. C premium received
loss = - infinite

Question 12

which positions are considered bullish?

Answer 12

buy stock
buy call
sell put

Question 13

which positions are considered bearish?

Answer 13

short selling stock
short selling call
buying put

Question 14

what is the position for a covered call, what does it aim to do?

Answer 14

Position: for every call you short you buy one stock
Aims: to reduce the loss of writing(short selling) a call

Question 15

what is the position for a protective put, what does it aim to do?

Answer 15

Position: for every stock you buy you buy a put
Aims: to reduce your potential loss when you buy a stock

Question 16

why would you want to create a synthetic put or call?

Answer 16

because they may not be traded on the market or the premium may be unacceptable.

Question 17

what is the put call party formula?

Answer 17

P + S = C + PV(X)

Question 18

what is a money spread? what are examples of money spreads?

Answer 18

taking an options and writing an option at the same time with different exercise prices.

ie bull or bear spread, collars, butterfly spread

Question 19

what is a time (calendar) spread? what is this technique based on?

Answer 19

taking an options and writing an option at the same time with different expiration date but same strike.

volatility

Question 20

why do investors use option spreads? 2

Answer 20

• reduce risk

- low costs of long positions

Question 21

what is a bull spread? position and aim

Answer 21

position: buy call with X1 and sell call with X2 where X1

Question 22

what is the profit formula for a bull spread?

Answer 22

cap pi = N1 (max(0, St-X1) - C1) + N2(max(0, St-X2) - C2)

N2 is negative and C1>C2

Question 23

when does a bull spread breakeven?

Answer 23

when St = X1 + C1 + C2

Question 24

what is a bull spread using calls? position and aim

Answer 24

position: sell a call with X1 and buy a call with X2 where X1

Question 25

what is the profit formula for a bear spread? using calls

Answer 25

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)

Question 26

what is a bull spread using puts? position and aim

Answer 26

position: sell a put with X1 and buy a put with X2 where X1

Question 27

what is the profit formula for a bear spread? using puts

Answer 27

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)

Question 28

when does a bear spread using puts breakeven?

Answer 28

St = X2 + P1 - P2

Question 29

what are collars similar to? whats the key difference?

Answer 29

bull spreads, the earn more, earn interest on X1

Question 30

what is the position and aim of a collar?

Answer 30

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

Question 31

what is the position and aim of a butterfly spread? position and aim

Answer 31

position: buy call with X1, buy call with X3, sell 2 calls with X2
aim: speculate that large stock price movements are unlikely.

Question 32

what is the profit equation for a butterfly spread??

Answer 32

cap pi = (max (0, St-X1) - C1) - (2max(0, St- X2) + 2C2) + (max(0,St-X3) - C3)

Question 33

what is a straddle? position and aim?

Answer 33

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

Question 34

what is a short straddle? why is it more risky?

Answer 34

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

Question 35

what is a strip? position and aim?

Answer 35

position: long 2 puts, long 1 call
aim: double up bet that stock will decrease

Question 36

what is a strap? position and aim?

Answer 36

position: long 2 calls, long 1 put
aim: double up bet that stock will increase