Derivatives, Insurance Securities & Other Investments Flashcards
Derivative
A derivative security is so named because its value is derived from the value of another asset, referred to as the underlying asset. As that asset’s value changes, so does the value of the derivative
What is then appeal of derivatives for investors
A big appeal with derivatives is that the change in their value is usually far greater, percentage-wise, than the value change in their underlying assets. In this sense, they are said to have built-in leverage.
Define and Option
An option is a contract between two people wherein one person grants the other person the right to buy a specific asset at a specific price within a specific time period. Alternatively, the contract may grant the other person the right to sell a specific asset at a specific price within a specific time period. Options have zero sum gains which means whatever the buyer gains the writer loses, and vice versa.
Option Buyer
The person who purchases the option for a premium price receives the right to exercise the contract. The option will either be the right to buy at the exercise (strike) price or the right to sell.
Option Writer
The person who receives a premium for creating the option contract has sold the right, and thus must respond to the buyer’s decision. If the buyer exercises the right to buy shares, then the writer of that option must deliver the shares. If the buyer exercises the right to sell, then the writer must come up with the money to purchase the shares.
Calls options
Calls are option contracts where the writer gives the buyer the right to purchase a set quantity of securities at the exercise price from the writer.
Puts options
Puts are option contracts where the writer gives the buyer the right to sell a set quantity of securities at the exercise price to the writer.
List the four elements of a Call option contract
The company whose shares can be bought,
The number of shares that can be bought,
The purchase price for those shares, known as the exercise price or strike price, and
the date when the right to buy expires, known as the expiration date.
What is a naked call option
A call option where the writer does not own the stock is called a naked option.
Covered call option
a covered call option is one where the writer of the call option already owns the underlying stock. In the event that the stock is called from the writer, they already own the shares to deliver to the buyer of the contract. The covered call writer only has one issue - are they willing to sell their shares for the contracted strike price? If so, this can be an excellent strategy to generate income until such time comes, when the stock is eventually called.
List the four options of a Put Option
he company whose shares can be sold,
The number of shares that can be sold,
The selling price for those shares, known as the exercise price or striking price, and
The date when the right to sell expires, known as the expiration date.
The Role of The Options Clearing Corporation
The Options Clearing Corporation (OCC) is a company that facilitates the trading of call and put options. It maintains a computer system that keeps track of all contracts by recording the position of each investor. As soon as a buyer and a writer decide to trade a particular put option contract and the buyer pays the agreed-upon premium, the OCC steps in, becoming the effective writer as far as the buyer is concerned and the effective buyer as far as the writer is concerned. All direct links between original buyer and writer are severed.
Futures Contracts
Futures are also known as futures contracts, which are based on the future delivery of commodities, like frozen orange concentrate, or financial instruments, like U.S. Treasury Bonds.
Marking To Market
The process of adjusting the equity in an investor’s account in order to reflect the change in the settlement price of the futures contract is known as marking to market. Each day, as part of the marking-to-market process, the clearinghouse replaces each existing futures contract. The new contract contains the settlement price reported in the financial press as the new purchase price.
Maintenance Margin
Another key margin account topic is the maintenance margin. According to the maintenance margin requirement, the investor must keep the account’s equity equal to or greater than a certain percentage of the amount deposited as initial margin. Typically, an investor must have equity equal to or greater than 65% of the initial margin.
