Final

Question 1

What are the different types of volatility option strategies?

Answer 1

-straddle
-straps
-stripes
Butterfly

Question 2

What is a straddle?

Answer 2

Simultaneously buy a call and a put option with the same strike price and same expiry date.

Question 3

When is straddle useful?

Answer 3

Expected increase in volatility, breakeven happens when underlying asset value differs from the strike price by an amount bigger than the premium paid

Question 4

What is a strangle?

Answer 4

Simultaneously buy call and put options with the same strike and maturity but they are out-of-the-money

Question 5

What are the pros and cons of a strangle?

Answer 5

pro: it serves the same purpose as the straddle but is much cheaper because it’s out-the-money

con: you have to wait some time until the action becomes in-the-money (if it ever does)

Question 6

What is a strap?

Answer 6

More expensive strat than straddle, provides double the profit on the upside (bullish expectation)

Question 7

How do you build a strap?

Answer 7

You buy 2 ATM calls + 1 ATM put

Question 8

What is a strip?

Answer 8

More expensive strat than straddle, provides double the profit on the downside (bearish expectation)

Question 9

How do you calculate the u in CRR

Answer 9

u: exp(stddev*sqrt(t))

Where stddev is yearly and t=T/N

Question 10

How do you calculate the d in CRR

Answer 10

1/u

Question 11

How do you calculate p (probability of up) in CRR

Answer 11

p:(exp(rt)-d)/(u-d)

Question 12

How do you find the forwards spot prices in CRR

Answer 12

Su = Su
Sd = Sd

Question 13

How do you find the payoffs of a call & put

Answer 13

Put: max(K-S,0)
Call: max(S-K,0)

Question 14

How do you discount the flows when pricing an option in CRR

Answer 14

S = (pSu+(1-p)SD)*exp(-rt)

Question 15

What are the two types of KO’s?

Answer 15

Up and out
Down and out

Question 16

What are the two types of KIs

Answer 16

Up and in
Down and in

Question 17

What is a reverse knock in

Answer 17

KI that is in the money when barrier is triggered

Put: H>K
Call: K>H

Question 18

What is call put parity?

Answer 18

C+PV(K) = P + S

Question 19

What does the call put parity tell us?

Answer 19

Buying a call and shorting a put is like a synthetic forward where you buy the contract at price K

Question 20

What is a protective put?

Answer 20

Protection against potential loss of owning a stock

Question 21

What does a protective put imply?

Answer 21

Buying put option while still holding underlying

Question 22

What are the different types of option spreads?

Answer 22

Collar
Vertical bear spreads
Call and put ratio spreads
Box spread

Question 23

What is a collar/hedge wrapper

Answer 23

Reduce negative returns + limit positive returns of underlying

Question 24

What is a vertical bull spread

Answer 24

Buying and selling two options of the same class but different K: reduce premium paid on strategy

Question 25

Ratio spreads

Answer 25

Number of options bought and sold are different

Question 26

Box spreads

Answer 26

Buying bull call spread and bear put spread with same strikes: borrowing or lending at implied rates that are more favorable than bank

Question 27

How do you do a butterfly spread with calls

Answer 27

Buy ITM call and OTM call, sell 2 ATM calls

Question 28

What are the assumptions for BSM

Answer 28

-risk free rate
-normally distributed
- no arbitrage
- no transaction costs
- Borrow/buy any amount