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CFP Exam > Derivatives > Flashcards

Derivatives Flashcards

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1
Q

what is an options contract?

A

an agreement between two parties, the seller (writer) and the buyer

derivative security

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2
Q

what determines the value of an option?

A

the value of the underlying asset

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3
Q

how many shares of the underlying security are in one option contract?

A

1 contract = 100 shares

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4
Q

what are the two types of options?

A

call option and put option

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5
Q

what is a call option

A

the right to BUY a specified number of shares at a specified price within a specified period of time or at a specified future date

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6
Q

what is a put option

A

the right to SELL a specified number of shares at a specified price within a specified period of time or at a specified future date

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7
Q

what is another name for the specified price that a contract is exercised at?

A

strike price (exercise price)

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8
Q

what is the difference between an American option and a European option?

A

American options can be exercised at any time prior to the expiration date

European options can only be exercised on the expiration date

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9
Q

what does the buyer of a call option believe about the price of the underlying stock?

A

the buyer of the call option believes the stock price will rise

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10
Q

wheat does the buyer of a put option believe about the price of the underlying stock?

A

the buyer of the put option believes the stock price will fall

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11
Q

what does the seller of a call option believe about the price of the underlying stock?

A

the seller of the call option believes the price will fall or stay the same

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12
Q

what does the seller of a put option believe about the price of the underlying stock?

A

the seller of the put option believes the price will rise or stay the same

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13
Q

what is the formula for the intrinsic value of a call option?

A

intrinsic value = stock price - strike price

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14
Q

what is the formula for the intrinsic value of a put option?

A

intrinsic value = strike price - stock price

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15
Q

can you have a negative intrinsic value?

A

no. if the calculation comes to a negative value, then the intrinsic value is $0

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16
Q

what is the formula for time value?

A

time value = premium - intrinsic value

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17
Q

practice problem: Holly purchases a call option on Starbucks. The strike price is $50 and the stock is trading at $53. The call expires in two months and the premium is $5. What is the intrinsic value of her call option? What is the time value?

A

intrinsic value = stock price - strike price
intrinsic value = $53 - $50
intrinsic value = $3

time value = premium - intrinsic value
time value = $5 - $3
time value = $2

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18
Q

when is a call “in the money”?

A

a call is “in the money” when: stock price > strike price

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19
Q

when is a call “out of the money”?

A

a call is “out of the money” when: stock price < strike price

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20
Q

when is a call “at the money”?

A

a call is “at the money” when: stock price = strike price

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21
Q

when is a put “in the money”?

A

a put is “in the money” when: stock price < strike price

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22
Q

when is a put “out of the money”?

A

a put is “out of the money” when: stock price > strike price

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23
Q

when is a put “at the money”?

A

a put is “at the money” when: stock price = strike price

24
Q

what does it mean to be “in the money”?

A

the intrinsic value is positive

25
Q

what does it mean to be “out of the money”?

A

the intrinsic value is negative (which then adjusts to be $0)

26
Q

what does it mean to be “at the money”?

A

the intrinsic value is $0 (calculation came to $0 directly, it wasn’t adjusted to be $0)

27
Q

what is a covered call?

A

involves selling call options on stock that is currently owned by the investor

28
Q

what is a married put?

A

this strategy involves buying a put option on a stock or index that is currently owned by the investor

aka “portfolio insurance”

29
Q

what is a long straddle?

A

an investor buys a put and a call option on the same stock

30
Q

when would an investor use the long straddle strategy?

A

when the investor expects volatility, but is unsure as to the direction

31
Q

what is a short straddle?

A

an investor sells a put and a call option

32
Q

when would an investor use the short straddle strategy?

A

when the investor does not expect volatility and is hoping to keep the premiums with little to no volatility in the stock price

33
Q

what is a collar

A

an investor owns the underlying stock, and sells a call option at a strike price that is slightly higher than the current stock price, creating a premium received

the investor then uses the dollars from the premium received to buy a put option that is lowed than the current stock price

34
Q

what is a collar

A

an investor owns the underlying stock, and sells a call option at a strike price that is slightly higher than the current stock price, creating a premium received

the investor then uses the dollars from the premium received to buy a put option that is lowed than the current stock price

35
Q

what are the types of option pricing models?

A
  • Black/Scholes
  • Put/Call Parity
  • Binomial Pricing Model
36
Q

describe the Black/Scholes pricing model

A
  • used to determine the value of a CALL option
  • all variables have a direct relationship on the price of the coupon, except the strike price
  • as the strike price increases, the option decreases in value
37
Q

describe the Put/Call Parity pricing model

A

attempts to value a PUT option based on the value of a corresponding call option

38
Q

describe the Binomial Pricing Model

A

attempts to value an option based on the assumption that a stock can only move in one of two directions

(ex: over the short-term you have determined that a security, now worth $10, will be either $12 or $8)

39
Q

how is a call option taxed if the contract lapses (or expires)?

A

the premium paid is a short-term loss and the premium received is a short-term gain

40
Q

how is a call option taxed if the contract is exercised?

A

the premium is added to the stock price to increase the basis in the underlying stock

if the underlying stock is held for more than 12 months, it is a long-term cap gain or loss

if the underlying stock is held less than or equal to 12 months, it is a short-term cap gain or loss

41
Q

what does LEAPS stand for?

A

Long Term Equity Anticipation Securities

42
Q

what is a LEAPS?

A

has an expiration period that lasts for 2 years or more (versus traditional options that have expirations up to 9 months)

has a higher premium because of the extended time period

43
Q

what is a warrant?

A

long-term call options issued by the corporation

expiration period is much longer than options, usually 5-10 years

terms are NOT standardized

44
Q

what is a futures contract?

A

a derivative contract that OBLIGATES the holder to make or take delivery of the underlying asset

futures contracts do not state the per unit

45
Q

what is a futures contract?

A

a derivative contract that OBLIGATES the holder to make or take delivery of the underlying asset

futures contracts do not state the per unit price of the underlying asset

46
Q

what are the two types of futures contracts?

A
  1. commodity futures contracts

2. financial futures contracts

47
Q

what is a commodity futures contract?

A

a futures contract where the underlying asset is copper, wheat, pork bellies, oil, etc.

48
Q

what is a financial futures contract?

A

a futures contract where the underlying asset is currency, interest rate, or stock indices

49
Q

what is the key difference between an option contract and a futures contract?

A

option contracts give the holder the RIGHT to do something

futures contracts OBLIGATE the holder to make or take delivery of the underlying asset

50
Q

if you are using the hedging strategy, and you are long in the commodity, what should you do?

A

short the contract

51
Q

if you are using the hedging strategy, and you are short the commodity, what should you do?

A

long the contract

52
Q

when you buy a call option, what is your max possible loss and max possible gain?

A

max loss = premium paid

max gain = unlimited

53
Q

when you sell a call option, what is your max possible loss and max possible gain?

A

max loss = unlimited

max gain = premium received

54
Q

if you buy a put option, what is your max possible loss and max possible gain?

A

max loss = premium paid

max gain = strike price - premium

55
Q

if you sell a put option, what is your max possible loss and max possible gain?

A

max loss = strike price - premium

max gain = premium received

CFP Exam (24 decks)

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