derivatives

Question 1

how many shares are in one option contract?

Answer 1

100 shares

Question 2

what are the two types of options?

Answer 2

call options and put options

Question 3

what is a call option?

Answer 3

RIGHT TO BUY

Question 4

what is a put option?

Answer 4

RIGHT TO SELL

Question 5

what does it mean if it is an American Option?

Answer 5

within a specified period of time

Question 6

what does it mean if it is an European Option?

Answer 6

at a specified future date

Question 7

what are the three reasons people will invest in options?

Answer 7

hedging
speculation
income

Question 8

buyers of call options believe…

Answer 8

the price of the underlying stock will RISE

Question 9

buyers of put options believe….

Answer 9

the price of the underlying stock will FALL

Question 10

sellers of call options believe…

Answer 10

the price of the underlying stock will fall or stay the same

Question 11

sellers of put options believe…

Answer 11

the price of the underlying stock will rise or stay the same

Question 12

how to calculate intrinsic value for a call and a put option

Answer 12

call option = stock price - strike price

put option = strike price - stock price

intrinsic value can never be less than 0

Question 13

how to calculate the time value of an option

Answer 13

time value = premium - intrinsic value

Question 14

what is a covered call trading strategy?

Answer 14

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

Question 15

what is a married put trading strategy?

Answer 15

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”

Question 16

what is a long straddle trading strategy?

Answer 16

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

investor expects volatility - but is unsure of the direction

Question 17

what is a short straddle trading strategy?

Answer 17

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

Question 18

what is a collar or zero cost collar trading strategy?

Answer 18

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

Question 19

What is the Black/Scholes Pricing Model?

Answer 19

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

Question 20

What is the Put/Call Parity Pricing Model?

Answer 20

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

Question 21

what is the Binomial Pricing Model?

Answer 21

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

Question 22

for call options, how are expired options taxed?

Answer 22

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

Question 23

how are exercised call options taxed?

Answer 23

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

Question 24

what are Long Term Equity Anticipation Securities (LEAPS)?

Answer 24

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

Question 25

what are warrants?

Answer 25

essentially long term call options issued by the corporation

expiration period is much longer than 9 months

not standardized

Question 26

what are the two types of futures contracts?

Answer 26

commodity futures and financial futures

Question 27

what are the differences between futures and options?

Answer 27

option contracts give the holder the right to do something; futures OBLIGATES the holder to make or take delivery of the underlying asset

futures do not state the per unit price of the underlying price, which is determined by supply and demand

Question 28

who are the players in the futures market?

Answer 28

hedgers and speculators