Chapter 4 Flashcards
OPTIONS
- What is an option
- What is a Call option
- What is a Put option
- What is Strike price
- What is Expiration date
Contract - Option top buy or sell stocks at an agreed price before a particular date.
Call option - Right (but not obligation) to BUY at an agreed price on or before particular date
Put Option - Right (but not obligation) to SELL at an agreed price on or before particular date
Strike price - Agreed upon price at which stock bought or sold
Expiration - date of option expiry
GH:
Option not obligation to purchase/sell an asset at a specified price on/before specified future date
- Buyer of option has right to exercise option, can trade out on exchange or allow it to exciter
- Arranged directly or through an exchange
- Call : right to buy Put:right to sell
On specified date = European befor - American
What is a Future Contract (3)
- Positions
- contract between 2 parties (buyers/seller). Has to be buy/sell (Derivatives)
(See futures video Money week) for agreed price at agreed date - T&Cs agreed today
- No premium
- Obligation to deliver - They are binding
Positions:
Seller - Short ‘S” for selling
Buyer - Long
Many futures are physically settled )not just traded ) eg commodities such as coffee, wheat , fuel for EasyJet…..Gives known cost and helps manages cash and prices
What is Long position (3)
- BUYER of contract
- Once agreed, Long hope prices will go up (compared to today )
- Long makes money in RISING market
Traders, on the other hand who take a “Long position” are going to make a profit in a rising market. Agreed a STRIKE price for the future and will make on margin. Betting on prices going up….Trading long
Short Position with a Future
- Short position is SELLER of underlying asset
- Shorts will make money in a falling market because they have agreed to sell at a higher price - marking between selling price and market price.
What is difference between Future and Forward
- Forward is direct deal between 2 parties
- Not sold on exchange
- Similar as both allow something to happen at some time in future
- Key difference is that Futures are exchange traded
- MAin disadvantage with Forward is COUNTERPARTY RISK - This is risk that obligations will not be met by either side
- Derivatives traded on exchanges, counterparty risk is managed and removed by LCH Clearnet
What is an Option
Buy/sell
- OPTION gives buyer the right but not obligation to buy or sell an underlying asset at a fixed price (strike price) on or before a given date in future
- SELLER does have obligation …. BUYER has choice (With FUTURES both buyer & seller have obligation)
- BUYER of an OPTION pays a premium to SELLER (no premium with Future)
CALL option: Holder has the right to buy the underlying asset - Buyer is on the LONG side. The SELLER (Writer) of the option is on the SHORT side.
PUT option: Holder has the right to SELL - opposite side of market
- Strike Price
- Intrinsic Value
- Time Value
- In the Money
- European Options / American Options
- Strike: price option specifies may be bought or sold. Has expiry date (last day of option’s life)
- Intrinsic Value : How much an option would be worth if it expired now (not including premium)
- Time Value: Where option has time before expiry.More time to expiry, the greater time value
- In the money: option with intrinsic value
HOLDER of option
- Long CALL option =
- Long PUT option =
SELLER/WRITER of option:
- Short CALL option =
- Short PUT option =
HOLDER of option
- Long CALL option = the right to BUY
- Long PUT option = the right to SELL
SELLER/WRITER of option:
- Short CALL option = a potential obligation to SELL (to the holder)
- Short PUT option = a potential obligation to BUY ( from the holder)
Hedge Funds
What are they
Benefits & Drawbacks (4)
- Features:
1. Secretive (privately owned and managed). 2. Flexible mandate eg use derivatives to great extent 3. Hedge funds claim to make absolute return 4. High fees
Term given to investment funds that adopt non traditional;l investment methods - Can adopt a numbers of “house”styles
- Long/short - combining long & short investments
- Relative value - indie tiffing price anomalies
- Event driven - Using world events as triggers to trade
Benefits: 1. Diversification 2. Expertise 3. Variety 4. Volatility
Drawbacks: 1. High cost 2. High entry level 3) complexity
4.Volatility
Moneyweek:
Features : 1. Privately owned - secret strategy (everyone would do it) 2. Unregulated 3. Lack liquidity.
Factors that determine the price of an option (6)
- Price of underlying instrument
- Interest rates
- Volatility
- Time to expiry
- Exercise price of option
- American or European
Contract for difference
- What is it
CFD is derivative
- Short term protection against downside eg fall in stock market. CAn sell “short” CFDS
Eg sell 10,000 CFDS for 550p. = £55,000
Deposit, say, 5% £2,750
Bid/Offer charge
WHat types of way can an investment position be hedged (6)
- Futures
- Contract for difference
- ETF (inverse)
- Option
- Swap
Spread betting
Swap:
- Forward contract (like a future)
- Exchange is one set of future cash flow for another
- Not available to retail investor
