Investment Companies _ Derivatives Flashcards
What are the three types of Investment Companies?
- Closed End
- fixed initial market cap, specific number of initial shares
- no new shares issued by fund
- shares trade at premium or discount to NAV - Open End
- unlimited number of shares
- shares issued as long as contributions are made
- shares bought and redeemed directly from fund family
- shares trade at NAV - Unit Investment Trust (UIT)
- no investment manager, managed by a Trustee
- passively managed and self-liquidating
- issues units not shares
- very thinly traded secondary market
How is Intrinsic Value calculated for call and put options?
Option premium consists of intrinsic value and a time premium.
Intrinsic Value
* Call Option = Stock Price - Strike Price
* Put Option = Strike Price - Stock Price
* Cannot be less than 0
Time Value = Premium - Intrinsic Value
What is In the Money, At the Money, and Out of the Money for Call and Put Options?
How do you calculate the gain or loss using Options?
Consider two components:
- Intrinsic value
- Premium paid or received
Remember “STOPS”
- St: Stock gain or loss if you own the underlying stock
- O: Options gain or loss
- P: Premium paid or received
- S: Shares controlled or owned
Remember BUYING A PUT (protection & locking in)
When asked a question about “protecting profits” or “locking in gains”, the right answer is always BUYING A PUT.
True whether a put on a single stock or an index to protect a diversified portfolio of common stocks.
What is a Covered Call?
selling call options when you own the stock
appropriate strategy when stock in trading range and investor wants additional income and keep the stock
appropriate if considering selling the stock but want additional premium dollars and possibly get called out of the stock
What is a Married Put?
“portfolio insurance”
buying a put option owned by someone else
What is a Long Straddle?
investor BUYS a put and a call on the same stock
investor expects volatility, unsure of the direction
What is a Short Straddle?
investor SELLS a put and a call option
investor does not expect volatility, hoping to keep premiums
What is a Collar or Zero-Cost Collar?
investor owns the underlying stock, wants to protect downside risk without paying the entire cost of the put option
investor sells a call option at a strike price that is slightly higher than the current stock price ==> premium received
investor buys a put option that is below the current stock price, premium from selling call used to buy the put options
What are the 3 different Option Pricing Models?
Black / Scholes
- determines value of a CALL option
- variables are (all direct relationship on option price except strike price):
- underlying asset current price
- time until expiration
- risk-free rate of return
- underlying asset volatility
Put / Call Parity
- value of a PUT option based on value of a call option
Binomial Pricing Model
- value an option based on assumption a stock can only move in one of two directions
How are options taxed?
Call options have 2 potential tax consequences:
- if contract lapses (or expires) the premium paid is a short-term loss, premium received a short-term gain
- if contract exercised, premium is added to stock price to increase underlying stock basis (use STCG/LTCG timing)
Put option
- if contract expires without exercise premium paid is a short-term loss and received a short-term gain
What are Long Term Equity Anticipation Securities (LEAPS)?
options w/ longer expiration periods than traditional options
have expiration periods of 2+ years vs. traditional up to 9M
premium is higher because of extended time period
What are Warrants?
long-term call options issued by the CORPORTATION
expiration period is much LONGER than options ~ 5-10Y
- call option periods <= 9M
terms are NOT STANDARDIZED
- call option contracts standardized in terms of expiration month & number of shares controlled
What are Futures Contracts?
commodities or financial
option contracts = the right
futures contracts = obligation
do not state the per unit price of the underlying asset, determined by supply & demand
marked to market
- gain or loss (in cash) is credited/debited to your account daily
