Derivatives and Risk Management (11.6.24)

Question 1

Put Call Partiy

Answer 1

Stock price + put premium = call premium + strike price/(1+r)^T

Question 2

Synthetic long forward position

Answer 2

The combination of a long call and a short put with identical strike price and expiration, traded at the same time on the same underlying

Question 3

Synthetic short forward position

Answer 3

The combination of a short call and a long put at the same strike price and maturity (traded at the same time on the same underlying)

Question 4

Delta

Answer 4

The relationship between option price and underlying price; shows how much an option price will change for a small change in the stock

Question 5

Gamma

Answer 5

A numerical measure of how sensitive an option’s delta (the sensitivity of the derivative’s price) is to a change in the value of the underlying

Question 6

Vega

Answer 6

The change in a given derivative instrument for a given small change in volatility, holding everything else constant

Question 7

Theta

Answer 7

The change in a derivative instrument for a given small change in calendar time

Question 8

Position delta

Answer 8

the overall/portfolio delta

Question 9

cash secured delta

Answer 9

an option strategy involving the writing of a put option and simultaneously depositing an amount of money equal to the exercise price into a designated account (also called fiduciary put)

Question 10

How are spreads classified

Answer 10

1) Market sentiment
2) Direction of the initial cash flows

Question 11

Bull spread

Answer 11

An option strategy that becomes more valuable when the price of underlying asset rises; requires buying one option and writing another with a higher exercise price

Question 12

bear spread

Answer 12

an option strategy that becomes more valuable when the price of the underlying asset declines; requires buying one option and writing another with a lower exercise price

Question 13

Debit spread

Answer 13

when the spread requires a cash payment by the investor; effectively long because the long option value exceeds the short option value

Question 14

credit spread

Answer 14

when the spread initially results in a cash inflow to the investor; effectively short because the short option value exceeds the long option value

Question 15

Long straddle

Answer 15

option combination in which one buys both puts and calls with the same exercise price and same expiration date on the same underlying asset

Question 16

Short straddle

Answer 16

option combination in which one writes both puts and calls with the same exercise price and the same expiration date on the same underlying asset

Question 17

When would you use a straddle

Answer 17

in anticipation of some event in which the outcome is uncertain but likely to significantly affect the price of the underlying asset, regardless of how the event is resolved

Question 18

Collar

Answer 18

option position in which the investor is long shares of stock and then buys a put with an exercise price below the current stock price and writes a call with an exercise price above the current stock price

Question 19

When would you use a collar

Answer 19

protect gains that has long-term potential but are concerned about short-term volatility; limits both potential gains and losses

Question 20

Calendar spread

Answer 20

a strategy in which one sells an option and buys the same type of option but with different expiration dates, on the same underlying asset and with the same strike

Question 21

Implied volatility

Answer 21

Standard deviation that causes an option pricing model (BSM) to give the current option price

Question 22

Realized volaility

Answer 22

Historical volatility, the square root of the realized variance of returns, which is a measure of the range of past price outcomes for the underlying asset

Question 23

Annual Standard deviation %

Answer 23

StD monthly % * sq (252/21)

Question 24

Volatility smile

Answer 24

the u-shaped plot (of implied volatility (y axis) against strike (x axis) for options on the same underlying with the same expiration) that occurs when the implied volatilities priced into both OTM puts and calls trade at a premium to implied volatilities of ATM options

Question 25

Volatility skew

Answer 25

The skewed plot (of implied volatility (y axis) against strike price (x axis) for options on the same underlying with the same expiration) that occurs when the implied volatility increases for OTM puts and decreases for OTM calls, as the strike price moves away from the current price

Question 26

Risk reversal

Answer 26

a strategy used to profit from the existence of an implied volatility skew and from changes in its shape over time. A combination of long (short) calls and short (long) puts on the same underlying with the same expiration is a long (short) risk reversal

Question 27

Term structure of volatility

Answer 27

The plot of implied volatility (y axis) against option maturity (x axis) for options with the same strike price on the same underlying. Typically, implied volatility is not constant across different maturities - rather, it is often in contango, long-term options implied volatilities are higher than near-term ones

Question 28

Implied Volatility surface

Answer 28

a 3-dimensional plot, for put and call options on the same underlying asset, of days to expiration (x axis), option strike prices (y axis), and implied volatilities (z axis). It simultaneously shows the volatility skew (or smile) and the term structure of implied volatility