derivatives Flashcards
how many shares are in one option contract?
100 shares
what are the two types of options?
call options and put options
what is a call option?
RIGHT TO BUY
what is a put option?
RIGHT TO SELL
what does it mean if it is an American Option?
within a specified period of time
what does it mean if it is an European Option?
at a specified future date
what are the three reasons people will invest in options?
hedging
speculation
income
buyers of call options believe…
the price of the underlying stock will RISE
buyers of put options believe….
the price of the underlying stock will FALL
sellers of call options believe…
the price of the underlying stock will fall or stay the same
sellers of put options believe…
the price of the underlying stock will rise or stay the same
how to calculate intrinsic value for a call and a put option
call option = stock price - strike price
put option = strike price - stock price
intrinsic value can never be less than 0
how to calculate the time value of an option
time value = premium - intrinsic value
what is a covered call trading strategy?
involves selling call options on stocks that is currently owned by the investor
allows the investor to generate some income but continue to own the stock
what is a married put trading strategy?
involves buying a put option on a stock or index that is currently owned by the investor
also called “insurance protection” if the investor owns a diversified portfolio of common stocks
“protecting profits” or “locking in gains”
what is a long straddle trading strategy?
an investor buys a put and a call option on the same stock
investor expects volatility - but is unsure of the direction
what is a short straddle trading strategy?
an investor sells a put and a call option
investor does not expect volatility and is hoping to get the premiums with little to no volatility in the stock price
what is a collar or zero cost collar trading strategy?
investor owns the underlying stock, but wants to protect the downside risk without paying the entire cost of the put option
investor sells a call option at a strike price that is slightly higher than the current stock price
then the investor buys a put option that is below the current stock price
What is the Black/Scholes Pricing Model?
used to determine the value of a CALL option using:
- current price of the asset
- time until expiration
- the risk free rate of return
- volatility of the underlying asset
What is the Put/Call Parity Pricing Model?
attempts to value a PUT option based on the value of a corresponding call option
what is the Binomial Pricing Model?
attempts to value an option based on the assumption that a stock can only move in one of two directions
for call options, how are expired options taxed?
premium paid is a short term loss and the premium received is a short term gain
how are exercised call options taxed?
premium is added to the stock price to increase the basis
if stock is held for over a year - long term gain/loss
if stock is held for less than a year - short term gain or loss
what are Long Term Equity Anticipation Securities (LEAPS)?
have longer expiration periods than traditional options (two years or more – normal options are up to 9 months)
premium is higher because of the extended time period
