DERIVATIVES, OPTIONS, FUTURES Flashcards
OPTIONS
Considered to be a “derivative security”
Value is derived from the price behavior of the underlying real or financial asset
CALL: gives owner the right but not the obligation to buy the stock at a predetermined (strike) price within a predetermined time period. (Usually less than a year) (Long must purchase the option and price of the option is paid to the Short)
Long position and Short (seller or writer)
For every transaction there is a CALL and a PUT, one wins and one loses, they collect the price of the option. They exactly offset one another in a Zero Sum Game
PUT: right but not the obligation to sell stock at strike price within a predetermined time period
Long (must purchase the option) or Short (seller or writer)
BULLISH STRATEGY: Long Call. Short Put
BEARISH STRATEGY: Long Put, Short Call
VALUATION OF STOCK OPTIONS
“In the Money”. Call option when strike price is LESS than the market price of the underlying security. Put option when the strike price is greater than the market price of the underlying security
“Out of the Money”. Call option: when the strike price is greater than the market price
Put option when the strike price is less than the market price
“At the Money” Strike price and market price are equal
Option Premiums change every day!!
VALUE = price (or premium) consists of intrinsic value plus time value
The more time before the option expires, the more value of time
PREMIUM = INSTRINSIC (or Fundamental) VALUE + TIME VALUE
Fundamental or Intrinsic Value of a call is stock price - strike price
FUTURES CONTRACTS
Buyer agrees today to pay for and take delivery of a commodity on a specific date in the future
Price is agreed today
Both parties have a legally binding obligation
Futures can be held until delivery date OR traded on the futures market
All trading is done on MARGIN
(Less than 1% are held to delivery)
The price of a futures contract can change each day. If the price increases, the buyer benefits, as the buyer has locked in at a lower price. LONG POSITION = BUYER BENEFITS when price goes up
If the price declines, then the buyer loses, as they buyer has already agreed to sell at a higher price SHORT POSITION benefits if price decreases
FUTURES MARKETS PLAYERS
HEDGERS: producers, processors, wanting to protect their interests in the underlying commodity; they provide the actual products being sold—they use futures contracts to lock in a price (frito lay locks in on corn)
SPECULATORS: Investors, trying to earn a profit on expected price swings of futures contracts; Long positions benefit if price increases; short positions benefit if price decreases
