CF chapter 20

Question 1

Call option

Answer 1

gives the owner the right to buy the asset

Question 2

At-the money

Answer 2

exercise price approximately equal to the current underlying asset price

Question 3

In the money

Answer 3

If immediately exercised the option would yield profit

Question 4

Out the money

Answer 4

immediate exercise would yield a negative amount

Question 5

Speculating motive

Answer 5

When investors use options to place a ‘bet’ on the direction in which they believe the price of the
underlying asset is likely to move

Question 6

Hedging motives

Answer 6

In order to reduce risk by holding contracts or securities whose payoffs are negatively correlated
with some risk exposure

Question 7

Call option value (C) at expiration

Answer 7

C=max (S−K,0)

S = stock price
K = exercise price (established before)
C = value of the call option

Question 8

Long call option profit (in €)

Long call option return (in %)

Answer 8

max S−K,0 −C0

Profit/C0 = max(K - S,0) /C0

C0 = Current price of the call option

Same for put option just with p instead of c

Question 9

Option returns are highly levered, for two reasons

Answer 9

1. For a small fraction of the current stock price, you are entitled to the full upward potential above
   the strike price (call option)
2. Option positions normally have a ‘multiplier’, i.e. they can only be engaged in for (usually) 100
   stock equivalents

Question 10

Credit default swap

Answer 10

Insurance + default risk

Seller of the CDS receives regular payments by the buyer but has to pay for any interest that the borrower of money on a loan cant repay if he defaults

Question 11

The value of a call (put) option increases:

The value of a put option increases

Answer 11

as the stock price increases (decreases) (and vice versa)

as the strike price decreases (increases) (and vice versa)

Question 12

put option

Answer 12

gives the owner the right to sell the asset at a future date for a fixed price

Question 13

stock option

Answer 13

gives the holder the option to buy or sell a share of stock on or before a given
date for a given price.

For example, a call option on 3M Corporation stock might give the holder the right to purchase a share of 3M for $75 per share at any time up to, for example, January 18, 2019. Similarly, a put option on 3M stock might give the holder the right to sell a share of 3M stock for $50 per share at any time up to, say, January 19, 2018.

Question 14

Option premium

Answer 14

This upfront payment compensates the seller for the risk of loss in the event that the option holder chooses to exercise
the option

Question 15

Put price at expiration

Answer 15

P = max(K-S,0)
K = exercise price
S = stock price
P = value of the put option

Question 16

Call put pairity formula

Call price =

Answer 16

Put price + Stock price - PV(strike price) (exercise price)

Question 17

call put pairity formula with dividends formula

Answer 17

C = P + S - PV(Div) - PV(K)

P = put price
S = stock price
K = strike price

Question 18

The value of an option increases with

Answer 18

The volatility of a stock because you dont have to exercise the option