B.3 Insurance, Collars, and Other Strategies Flashcards
Position: Written Collar
1) Written put option
2) Purchased call option with higher strike price
Position: Purchased Collar
1) Purchased put option
2) Written call option with a higher strike price
Position: Bull Spread with put options
1) Purchased put option
2) Written put option with higher strike price
Position: Bear Spread with call options
1) Written call option
2) Purchased call option with higher strike price
Position: Bull Spread with call options
1) Purchased call option
2) Written call option with higher strike price
To create a Bull Spread, the investor (writes/purchases) the option with the higher strike price.
The investor writes the option with the higher strike price in creating a Bull Spread. There are two possibilities:
1) Purchase a call option and write a call option with a higher strike
2) Purchase a put option and write a put option with a higher strike
To create a Bear Spread, the investor (writes/purchases) the option with the higher strike price.
The investor purchases the option with the higher strike price in creating a Bear Spread. There are two possibilities:
1) Write a call option and purchase a call option with a higher strike
2) Write a put option and purchase a put option with a higher strike
Buying a stock and writing a call option has the same payoff at expiration as (lending/borrowing) an amount equal to the present value of the strike price and writing a put option.
Lending.
Long stock + short call = bond PV(K) + long put
Own stock + write call = lend PV(K) + write put
Profit(short stock + long call) is equivalent to ___________.
Profit(Long put)
Out-of-the-money option
Option that if exercised immediately would have a negative payoff.
At-the-money option
Option for which the strike price is approx. equal to the asset price.
In-the-money option
Option that if exercised immediately would have a positive payoff (but not necessarily a positive profit)
A call option is insurance for a ________ position.
Short; i.e. it hedges against the price risk of an asset you plan to own in the future.
A put option is insurance for a ________ position.
Long; i.e. Insurance on an asset already owned.
The profit on a long position in a stock and a put option is equivalent to that of a _________ option.
Purchased call option
Profit(long stock + long put) = Profit(long call)
Give 2 differences between a synthetic forward and a normal forward.
1) Synthetic forward pays price K instead of forward price
2) Synthetic forward requires payment of net option premium
In what scenarios (with respect to the underlying asset) are covered calls written?
When the price of the underlying asset is expected to stay the same.
*the profit on a covered call is equivalent to that of a written put
Position: Long on asset and write a call option on that asset
Covered Call
What is covered writing?
Writing an option when you have a corresponding long position in the underlying asset.
Position: Short an asset, write a put option
Writing a covered put
The profit on writing a covered call is equivalent to the profit on a __________ option.
Written put option.
Profit(long stock + long put) = profit on _________ option.
Long call option.
Profit(long asset + written put option) = Profit(purchased call option)
The profit on a covered put (short asset and write a put) is equivalent to the profit on a ___________ .
Written Call
Payoff(long position + purchased put + borrow PV strike) is equivalent to the payoff on ________.
Purchased call option.
Position: Own an asset, write a call option
Writing a covered call
Covered calls have potential for ________ when the asset price increases, and the potential for ________ when the asset price decreases.
Limited profit when price increases
Large loss when price decreases
Position: spread
Position with only calls or only puts
How are bull spreads used?
A lower cost way to speculate that asset price will rise
Position: Synthetic Long Forward
Purchase a call and write a put with the same strike price
Position: synthetic short forward
Purchase a put option and write a call option with the same strike price
A synthetic long forward with a strike price less than the forward price has a (positive/negative) net option premium.
Positive - you are locking in a price less than the forward price, so you must pay a premium equal to the cost of the call option minus the proceeds from selling the put option.
A synthetic long forward with a strike price greater than the forward price has a (positive/negative) net option premium.
Negative; asset is purchased at a premium relative to forward price so a net payment is received equal to the proceeds from the put option - cost of call option.
When the strike price is equal to the forward price the net option premium is _________
Zero. Cost of call option = Cost of put option
Put Call Parity
The net cost of buying an asset using options must equal the net cost of buying an asset using forwards
What is the cost of buying an asset using a forward at t = 0
PV(Fwd price)
Cost of buying an asset using options at t = 0
[Call(K,T) - Put(K,T)] + PV(K)
Put-Call parity in terms of the bargain element
PV(Fwd price - K) = Call(K,T) - Put(K,T)
Box spread
Create synthetic long and short forwards at different prices; equivalent to buying a bull spread + buying a bear spread
Ratio spread
Constructed by buying m calls at one strike price and selling n calls at a different strike price; exactly like a bull spread, but the number of calls isn’t 1
Position: Collared stock
Buy a stock, buy a put, and sell a call with a higher strike price
- selling the call helps to pay for the purchase of the put
- just like a bull spread with different instruments
