Chapter 14 Flashcards
Call Option
Right to buy underlying financial instrument at exercise price within a specified period of time.
Put Option
Right to sell underlying financial instrument at exercise price within a specified period of time.
In the Money
(Call) Market price > exercise price
(Put) Market price < exercise price
At the Money
Market price = exercise price
Out of the Money
(Call) Market price < exercise price
(Put) Market price > exercise price
Options vs. Futures
To obtain an option, a premium must be paid in addition to the price of the financial instrument.
The owner of an option can let it expire without exercising it.
Types of Orders
An investor can use either a market order or a limit order for an option transaction.
Influence of the Market Price (Call)
The higher the existing market price of the underlying financial instrument relative to the exercise price, the higher the call option premium.
Influence of the Stock’s Volatility (Call)
The greater the volatility, the higher the call option premium.
Influence of the Call Option’s Time to Maturity (Call)
The longer the call option’s time to maturity, the higher the call option premium.
Influence of the Market Price (Put)
The higher the existing market price relative to the exercise price, the lower the put option premium.
Influence of the Stock’s Volatility (Put)
The greater the volatility, the higher the put option premium.
Influence of the Put Option’s Time to Maturity (Put)
The longer the time to maturity, the higher the put option premium.
How Option Pricing can be Used to Derive a Stock’s Volatility
Some investors assess a specific stock’s risk by using the option-pricing formula to estimate the stock’s anticipated volatility.
