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CFP > Derivatives > Flashcards

Derivatives Flashcards

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1
Q

What is a derivative?

A

Values derived from the value of an underlying security or asset use for hedging and speculation

Futures and options

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2
Q

What are the key differences between futures and options?

A

Features contracts “obligate” both investor to purchase or sale of an item.

Options give an investor a “choice” to purchase or sell an item

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3
Q

What are futures?

A

Agreement between two parties to make or take delivery of a specific commodity of a specific quality at a future time place, and unit price

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4
Q

Futures contracts require what kind of account?

A

Margin account with an initial deposit and a required minimum balance

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5
Q

What is the daily settlement of a futures contract?

A

Losses must be realized in cash daily if decrease below maintenance margin will result in a margin call to restore account level of initial margin

Gains maybe withdrawn from the account

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6
Q

What is the Long position in a future’s contract?

A

Purchase a future contract (take delivery)

A long position will increase the value if the underlying commodity asset increases in value

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7
Q

What is the short position of a future contract?

A

Sale of a future’s contract (make delivery)

A short position will increase in value if the underlying asset decreases in value

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8
Q

What does “futures price” mean in a future’s contract?

A

Price specified in the contract for future delivery of the asset

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9
Q

What does “spot rate” mean in a future’s contract?

A

Current price of the commodity

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10
Q

What does “daily limit” mean in a future contract?

A

Maximum change in a commodities price that is permitted during the trading day

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11
Q

What does “Open Interest” mean in a futures contract?

A

Number of contracts, outstanding for particular futures contract

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12
Q

What is hedging in future’s contracts?

A

Reduce risk associated with fluctuating commodity prices

Entering into a future’s contract opposite of the position currently held

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13
Q

What is a short hedge in a future‘s contract?

A

Using a short future position to hedge a long future position

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14
Q

Short hedge example for future contracts

A

Farmer grows and sells wheat, farmer has a long position in wheat farmer will benefit when the price increases. If the price of weed declines, the farmer loses money. Therefore the farmer is subject to price changes in wheat. To eliminate the farmers risk exposure to price fluctuations, The farmer can use a short hedge

To use a short hedge, farmer must take a short position in wheat by selling a wheat futures contract. Farmer has a long position, the wheat crop, and a short position, the futures contract, the farmer has a limited the risk of price fluctuations if the price of wheat increases, the value of the crop increases. If the price of wheat declines, the value of the futures contract increases.

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15
Q

What is a long hedge in a future’s contract?

A

Using a long future position to hedge a short future position

Long, he works similar to the short hedge with the exception that the long hedge involves a producer concerned about fluctuations in the prices of raw materials.

The long hedge allows a user of raw materials to eliminate the risk of price fluctuations

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16
Q

How are taxes treated on futures contracts?

A

Gains and losses on futures contracts are considered capital gains and losses, regardless of the underlying assets

Net gains or losses are treated as 60% long term / 40% short term regardless of the actual breakdown

All open positions at the end of the tax year are treated as if they had been closed on the last day of the year for tax purposes therefore, any gain or loss inherit in the contract must be reported annually

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17
Q

What is a call option?

A

Right to purchase the underlined security for a specified price within a specified time

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18
Q

What is a covered call option?

A

Writer of the option owns the underline security, least risk

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19
Q

What is a naked call option?

A

Writer of the option does not own the underlying security, unlimited risk

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20
Q

What is a put option?

A

Right to sell the underlying security for a specified price within a specified period

21
Q

What is portfolio insurance using options?

A

Purchase of a put index option, reflective of the portfolio to protect an investor portfolio against a market downturn

22
Q

What is a protective put?

A

Same as portfolio insurance, or a hedged portfolio is constructed by holding a long position in the underlying security and buying a put option

23
Q

Why would an investor purchase a call option position?

A

Purchased to participate in the upward price move of a security

24
Q

Why would you sell (write) a call option position?

A

You expect a stock to not continue to rise and Not expected to continue to rise in price, you hope that the price will remain steady or decline. You then collect the Premium that you were paid.

If the price rises the seller may be required to deliver the stock to the option buyer the seller would receive the price as the sale price in addition to the premium for writing the option.

25
Q

Why would you purchase a put option position?

A

Purchased to provide downside protection for a Long position because you expect the stock price to decline

26
Q

Why would you sell (Write) a put option position?

A

Investor hopes that the stock price will rise

If the stock price declines, the stock may be put on the seller of the option. The seller will have to buy the stock at the exercise price, but will also receive the premium for writing the option.

27
Q

What is the premium on an options contract

A

Price to purchase an option contract amount the seller receives for writing the contract

28
Q

What is intrinsic value and how is it calculated?

A

Minimum price at which option will trade is the difference between the market price of the stock and the exercise price but not less than zero

Call: intrinsic value = Market Price - Exercise Price

Put: intrinsic value = Exercise Price - Market price

29
Q

What is time value of an option?

A

Amount by which the trading value of the option exceeds its intrinsic value and is considered the markets perceived worth of the time remaining until the expiration date

Ex book 3, page 38

30
Q

What does “In The Money” mean for an option?

A

The exercise price is below the market price for a call option, above the market price for a put option

31
Q

What does at the money mean for options?

A

Exercise price equals the market price for both calls and put

32
Q

What does “out of the money” mean for options?

A

Exercise price is above the market price for a call option below the market price for a put option

33
Q

What is the difference between American versus European options?

A

American options: exercise at anytime during the contract period

European options can only be exercised on Expiry date

34
Q

If an investor buys a call, what is his max gain and max loss?

A

Max gain is unlimited

Max loss is the premium paid

35
Q

What is the max gain and max loss to an investor who sells a call option?

A

Max gain premium received

Max loss is unlimited if naked, if not naked and it is covered investor loses the underlying security

36
Q

What is the maximum gain or maximum loss to an investor who buys a put option?

A

Max gain is exercise price less premium paid

Max loss is the premium paid

37
Q

What is the max gain or max loss to an investor who sells a put option?

A

Max gain is the premium received

Max loss is the exercise price less premium received

38
Q

When a call is exercise what is the taxes if an investor is the holder or if the investor is the writer?

A

Investor is the holder: add the premium to the basis in the stock purchased

Investors the writer: increase amount realized on sale of the stock by the amount received for the call

39
Q

When I call option expires, what is the taxation if the investor is the holder or if the investor is the writer?

A

Investor is the holder: report the call premium as a capital loss on the expiration date

Investors is the writer: report the amount received for the call as a short term capital gain

40
Q

When I call option is closed by taking an offset position what is the taxes if the investor is the holder or if the investor is the writer?

A

Investor is the holder: report the difference between the cost of the call and the amount received as a capital gain or loss

Investors is the writer: same as the holder

41
Q

When I put option is exercised what is the taxation if the investor is the holder or if the investor is the writer?

A

Investor is the holder: reduce amount realized from sale of the underlying stocked by the cost of the put

Investor is the writer: reduce spaces in the purchased stock by the amount received for the put

42
Q

When a put expires, what are the taxes if the investor is the holder or the investor is the writer?

A

Investor is the holder: report the put premium as a loss on the expiration date

Investor is the writer: report the amount received for the put as a short term capital gain

43
Q

When I put option is closed by taking an offsetting position, what is the taxes if the investor is the holder or if the investor is the writer?

A

Investor holder: report the difference between the cost of the and the amount received as a capital gain or loss

Investor is the writer: same as the holder?

44
Q

What is the Black - Scholes option Model?

A

Estimates the price of a European call option

45
Q

What are long-term Equity Anticipation Securities (LEAPS)

A

Put and calls with lengthy expiration dates expire within 2 to 3 years of initial listing date

46
Q

What is a zero cost collar?

A

Used to protect a gain in a long position with no cash outlay

Consist of a long position in a stock, a long put option, and a short call option

Investor purchases a put option to protect against downside risk and sells a call option to generate premium income to cover the cost of the premium paid for the put option

47
Q

What is a warrants?

A

Give the holder the right to purchase a certain number of shares of a specified common stock at a predetermined price for a specified period of time

Usually have longer lives and options typically have lives up to five years

Issued by companies

Exercise prices set well above the current market price of the stock

48
Q

What are rights (preemptive rights or subscription rights)?

A

Right to maintain a proportionate ownership in a company

Allows the holder to buy new issues before the company offers them to the general public

Allows stockholders to purchase common stock below the current market price of the stock

Short term usually expires within 45 to 60 days

CFP (17 decks)

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