Futures and Option Strategies Flashcards
Call Option
Option contracts where the writer gives the buyer the right to purchase a set quantity of securities at the exercise price from the writer.
Put Option
Option contracts where the writer gives the buyer the right to sell a set quantity of securities at the exercise price to the writer.
Security X has a current put price of $3, a strike price of $20, a market price of $22, and 30 days till expiration. If the risk-free rate is 1.5%, what is the current price of a call for security X for the same strike price and maturity?
C−P=S−PV(X)
C=S−PV(X)+P (Tip: Add P to each side to isolate C)
C=S−[X(1+r)T]+P (Tip: Present value of the strike price.)
C=22−[20 / (1.015) power (30/365)]+3
C=22−[20 / 1.0012]+3
C=22−[19.98]+3
C=$5.02
The difference between option contracts and futures contracts is that a futures contract gives the right to exercise the contract, but an option contract is an obligation to deliver.
Choose the best answer.
True False
False
The buyer of an option contract can just let the contract expire without exercising. Buyers of futures contracts are obligated to pay and take delivery of the commodity on a set date.
Your client owns a diversified equity portfolio worth $250,000. Based on economic projections and other market projections, you would like to protect this portfolio against a drop in the market. Which of the following S&P futures contracts would you enter to achieve this objective, and what is the reason for that position?
1) A long position to hedge against higher stock prices
2) A short position to hedge against lower stock prices
2) A short position to hedge against lower stock prices
Since the client already owns the stocks, he is long the stocks. The investor would take a short position (short hedge) to hedge the portfolio against a decline in value.
What does the futures market clearing house use to ensure it always has a sufficient security deposit to protect it from losses due to individual investors actions? (Check all that are true.)
1) Daily marking-to-market procedure
2) Margin requirements
3) Reverse trades
4) Breaking transaction
1) Daily marking-to-market procedure
2) Margin requirements
A futures contract is replaced every day by adjusting the equity in the investor’s account and drawing up a new contract that has a purchase price equal to the current settlement price. The daily marking-to-market procedure, coupled with margin requirements, results in the clearinghouse always having a security deposit of sufficient size to protect it from losses owing to the actions of the individual investors.
Which of the following statements are true regarding buyer’s and seller’s expectations about the performance of underlying stocks and associated options is (are) correct?
1) A seller of puts desires the option(s) to be exercised.
2) A buyer of a put option expects the price of the stock to move down.
3) A buyer of a call expects the stock price to move upward.
4) A seller of calls expects the price of the stock to hold steady or move upward.
(1) only
(1) and (2) only
(2) and (3) only
(1) and (4) only
(2) and (3) only
A seller of calls expects the price of a stock to hold roughly steady or move down so that the buyer has no incentive to exercise them. The seller of a call option would turn a profit to the extent of a premium less commissions. (2) and (3) are correct statements.
A financial planner has made the following transactions: buys 1 XYZ 35 call at 2; buys 1 XYZ 35 put at 2.5. The financial planner:
1) Has effectively created a straddle
2) Will most likely benefit from a volatile market
3) Has created a debit spread
4) Has created an effective hedge position
(1) and (4) only
(1) and (2) only
(3) and (4) only
(2) and (3) only
(1) and (2) only
The planner has created a long straddle and desires a volatile market to increase the chance of exercise.
An investor who wants to protect against a market downturn could utilize which of the following transactions?
Short selling
1) Purchasing a call option
2) Purchasing a put option
3) Purchasing a put option
(2) and (3) only
(1) and (2) only
(1), (2) and (3)
(1) and (3) only
(1) and (3) only
Either a put or short sale can be used to benefit from a market downturn. A call option benefits when a market rises.
A stock sells for $50 per share. The exercise price on a put option on that stock is $52. The premium on the put option is $7. What is the intrinsic value of this put option?
1) $0
2) $5
3) $2
4) $7
3) $2
The intrinsic value of a put option is the exercise price less the market price of the underlying stock ($52-$50= $2).
An investor purchases a 1-month out-of-the-money American call option on a stock. A week later, the stock price is less than the call option strike price. The time value of the option is most likely:
1) A positive amount
2) A negative amount
3) Zero
1) A positive amount
An American option will sell for more than its intrinsic value, thus implying a positive time value.
