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CFP > Investments: Derivatives > Flashcards

Investments: Derivatives Flashcards

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CFP® flashcards
1
Q

What is an option?

A

An Option is a derivative security

All transactions are handled through an option clearing house.

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2
Q

What determines the value of an option?

A

The value of an option depends on (is derived from) the value of another underlying asset.

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3
Q

What is an option contract?

A

Agreement between two parties, the seller (or writer) and the buyer

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4
Q

How many shares does one option contract control?

A

100 shares

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5
Q

What is a call option?

A

-the right to buy a specified number of shares at a specified price (strike or exercise price) within a specified period of time (American options) or a specified future date (European options)

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6
Q

What is a put option?

A

the right to sell a specified number of shares at a specified price (strike or exercise price) within a specified period of time (American options) or at a specified future date (European options).

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7
Q

What are the three reasons people invest in options?

A
  1. hedging
  2. Speculation
  3. Income
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8
Q

Call & Put Option Diagram

A
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9
Q

What does an option premium consist of?

A

It consist of intrinsic value and time premium

Intrinsic Value + Time Premium

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10
Q

How is intrinsic value of an option premium calculated?

A

Call option: stock price - strike price

Put option: strike price - stock price

*intrinsic value cannot be less than 0

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11
Q

Out, in or at the money?

A
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12
Q

Calculating again or loss using options: “StOPS”

A

St: stock gain or loss - if you own the underlying stock

O: Options gain or loss (*intrinsic value)

P: premiums paid or received

S: shares controlled or owned

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13
Q

Selling call option - example

A
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14
Q

Selling Put Options - example

A
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15
Q

What is a covered call?

A
  • selling call options on a stock that is currently owned by the investor.
    https: //www.youtube.com/watch?v=vFiIDopDqhQ
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16
Q

When is a covered call appropriate?

A
  • for a stock that has been trading in a range, and the investor wants to generate some income but continue to own the stock.
  • if an investor is considering selling a stock, but wants to generate some additional premium dollars and possibly get called out of the stock.
17
Q

What is a married put?

A

Buying a put option on a stock or index that is currently owned by the investor.

18
Q

What is a long straddle?

A

purchasing a put and a call option on the same stock.

Used if the investor expects volatility but is unsure as to the direction

19
Q

What is a short straddle?

A

An investor sells a put and a call option on the same stock

Investor does not expect volatility and is hoping to keep the premiums with little to no volatility in stock price.

20
Q

What is a Collar or Zero-Cost collar?

A
  1. Investor sells a call option at a strike price that is slightly higher than the current strike price. This creates a premium received.
  2. Investor buys a put option below the current stock price using the premium received by selling the call.
21
Q

When would you use a collar or zero cost collar?

A

When an investor owns the underlying stock and wants to protect the downside risk without paying the entire cost of the put option.

22
Q

What are the 3 option pricing models?

A
  1. Black/scholes
  2. Put/Call Parity
  3. Binomial Pricing Model
23
Q

What is the Black/Scholes model?

A
  • used to determine the value of a CALL option
  • considers the following variables:

current price of underlying asset
Time until expiration
Risk free rate of return
Volatility of underlying asset

  • all variables have a direct relationship on the price of the option.
  • as strike price increases, option price goes down.
24
Q

What is the Put/Call Parity?

A

Attempts to value a PUT option based on the value of the corresponding call option

25
Q

Binomial Pricing Model

A

-attempts to value an option based on the assumption the stock can only move in one of two directions.

26
Q

Taxability of options: call

A
  • if contract lapses ( or expires) premium paid is a short term loss and the premium received is a short term gain.
  • if contract is exercised, premium is added to stock price to increase basis in stock,
27
Q

Tax ability of options: Put

A
  • if contract expires without being exercised, the premium paid is a short-term loss and the premium received is a short term gain
28
Q

What are Long term equity anticipation securities (LEAPS)?

A
  • have longer expiration periods than traditional options.
  • expirations that last for two or more years.
  • traditional options have premiums of 9 months or less.
  • premiums are higher due to extended time period
29
Q

What are warrants?

A
  • long term call options issued by the corporation.
  • expiration usually 5-10 years
  • terms are not standardized. Call options are generally standardized in terms of expiration month and number of shares.
30
Q

Option example: client owns the stock

A
31
Q

What are the two types of futures contracts?

A

Commodity futures contracts; underlying asset is copper, wheat, pork bellies, oil.

Financial futures contracts: underlying asset is currency interest rates, and stock indices

32
Q

What are the differences between futures and options contracts?

A
  • options give the holder the right to do something; futures obligate the holder to make or take delivery of the underlying asset.
  • futures do not state the per unit price of the underlying asset, which is determined by supply and demand.
33
Q

Future contracts are “marked to market”, what does that mean?

A

The gain or loss (in cash) is credited/debited to your account on a daily basis

34
Q

What is the loss potential for selling and buying puts/calls?

A

Buying a put - option premium paid
Buying a call - option premium paid
Selling a naked put - strike price
Selling a naked call - unlimited

CFP (27 decks)

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