Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Investment Planning > Derivatives > Flashcards

Derivatives Flashcards

1
Q

Describe Options:

A
  • A derivative security
    • value depends on (is derived from) the value of another underlying asset
  • Two parties
    • the seller (the writer) and the buyer
  • All transactions handled through options clearing house
  • One option controls 100 shares of underlying security
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is a call option?

A
  • The right to buy a specified number of shares at a specified price (strike or exercise price) within a specified period of time (American) or at a specified future date (European)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is a put option?

A
  • The right to sell a specified number of shares at a specified price (strike or exercise price) within a specified period of time (American) or at a specified future date (European)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What are three reasons people invest in options?

A
  1. Hedging
  2. Speculation
  3. Income
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Describe call and put options from both sides:

A

Call Options Put Options

Buyers Believe the price of the under- Believe the POTUS will fall

lying stock will rise.

Sellers Believe the price of the under- Believe the POTUS will rise

lying stock will fall or stay or stay the same

the same.

EXAM TIP: buying a call will provide the investor max gains anytime CFP asks; buying a put is the right answer if the stock price falls

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

How do you calculate the value of an option?

A
  • Intrinsic Value
    • Call Option: Stock Price - Strike Price
    • Put Option: Strike Price - Stock Price
      • Intrinsic Value cannot be less than 0 (zero)
  • Time Value
    • TV = Premium - Intrinsic Value
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Describe Calls and Puts that are “in the money”, “at the money” and “Out of the Money”

A
  • Call
    • In the money - Stock Price > Strike Price
    • At the money - Stock Price = Strike Price
    • Out of the money - Stock Price < Strike Price
  • Put
    • In the money - Stock Price < Strike Price
    • At the money - Stock Price = Strike Price
    • Out of the money - Stock Price >Strike Price
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

How do you calculate gain/loss using options?

A
  • Consider two components
    • The intrinsic value of the option, and
    • The premium paid or received
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is the mnemonic for calculating gain/loss on an option position?

A
  • STOPS
    • St: Stock gain or loss - if you own the underlying stock
    • O: Options gain or loss
    • P: Premium paid or received
    • S: Shares controlled or owned

Examples on p.123 of blue IP book

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a Covered Call?

A
  • Option Trading Strategy
    • Sell call options on stock currently owned by investor
      • Appropriate for:
        • Stock in trading range, investor wants to generate income but continue to own stock
        • Investor considering selling stock, but wants to generate some additional premium dollars and possibly get called out of the stock.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is a Married Put?

A

Option Trading Strategy

  • Buying a put option on a stock or index currently owned by the investor
    • also known as “portfolio insurance” if investor owns a diversified portfolio of common stocks.

EXAM TIP: if question asks about “protecting profits” or “locking in gains” the right answer is always buying a put, either single stock or diversified portfolio of common stocks.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is a Long Straddle?

A

Option Trading Strategy

  • Investor buys a put and a call option on the same stock
    • Investor expects volatility, but is unsure of the direction
    • Ex: Boeing/McDonnell Douglas competing for a contract, one will go up and the other down
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is a Short Straddle?

A

Option Trading Strategy

  • Investor sells a put and a call option
    • Investor does not expect volatility and is hoping to keep the premiums with little to no volatility in the stock price
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q
A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is a Collar or Zero-Cost Collar?

A

Option Trading Strategy

  • When investor owns underlying stock, but wants to protect downside risk without paying entire cost of the put option
    • Investor sells a call option at a strike price that is slightly higher than the current stock price. This creates premium received.
    • Investor then buys a put option that is below the current stock price. The premium dollars received by selling the call are used to buy the put optins
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What are the Black/Scholes Option Pricing Model?

A
  • Black/Scholes
    • used to determine the value of a CALL option
    • Variables:
      • Current price of underlying asset
      • Time until expiration
      • The risk-free ROR
      • Volatility of the underlying asset
    • All variables have a direct relationship on the price of the option, except the strike price. As the strike price increases, the option decreases in value

EXAM TIP: KNOW

17
Q

What is the Put/Call Parity Option Pricing Model?

A
  • Attempts to value a PUT option based on the value of the corresponding call option
18
Q

What is the Binomial Option Pricing Model?

A
  • Attempts to value an option based on the assumption that a stock can only move in one of two directions ($10 stock, will be worth $12 or $8)
    • Model can be extrapolated further into the future based on the value achieved at each interval
    • Example: p. 127
    • Simplistic, but used by many major brokerage firms
19
Q

Describe the taxability of options:

A
  • Calls:
    • Two potential tax consequences:
      • If contract lapses (or expires), premium paid is a short-term loss and premium received is a short-term gain
      • If contract is exercised, premium is added to the stok price to increase the basis.
        • If stock is held more than 12 months, then long-term gain/loss. Less than 12 monts, short-term gain/loss
  • Puts
    • Not likely to be tested
    • KNOW: if not exercised, premium paid is short-term loss and premium received is a short-term gain
20
Q

What are LEAPS?

A
  • Long-Term Equity Anticipation Options
    • longer expirations periods than traditional options
    • Two years or more vs. traditional options that have expirations up to 9 months
    • Premium for LEAPS is higher because of extended time period
21
Q

What are Warrants?

A
  • Long-term call options issued by the corporation
  • Longer expiration period, usually 5-10 years
  • NOT standardized
22
Q

Describe Futures Contracts:

A
  • Two Types:
    • Commodity
      • Copper, wheat, pork bellies, oil
    • Financial
      • Currency, interest rate, stock indices
  • Differences from Options contracts
    • Futures obligate the holder to make or take delivery, options give the holder the right to do something
    • Futures do not state the per unit price of the underlying asset, which is determined by supply and demand
  • Primary Players in futures market
    • hedgers and speculators
  • Futures contracts are “marked to market”
    • The gain or loss (in cash) is credited/debited to your account on a daily basis

Investment Planning (8 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions