Lecture 15

Question 1

Protective put =

Answer 1

Purchase of stock combined with put option that guarantees minimum proceeds which are equal to the put’s exercise price

Question 2

Protective puts can be used as insurance against

Answer 2

Stock price declines

Question 3

Protective puts lock in

Answer 3

Minimum portfolio value

Question 4

Cost of insurance =

Answer 4

Put premium

Question 5

Covered calls =

Answer 5

Purchase stock and write calls against it

Question 6

Call is ‘covered’ because

Answer 6

Potential obligation to deliver stock is covered by the stock held in the portfolio

Question 7

Call writer gives up any stock value…

Answer 7

Above exercise price in return for initial premium.

Question 8

Covered calls forfeit

Answer 8

Potential capital gains should the stock price rise above the exercise price

Question 9

Long straddle =

Answer 9

Buy call and put with same exercise price and maturity and bet on volatility

Question 10

Straddle useful for investors

Answer 10

Who believe there will be large movements in stock price, but uncertain about direction of move

Question 11

Worst-case scenario for straddle strategy

Answer 11

No movement in stock price > call and put expire worthless and investor loses outlay for purchase of both options

Question 12

To make a profit in straddle

Answer 12

Change in stock price must exceed cost both options

Question 13

Writer of straddle is betting

Answer 13

Stock price will not change much

Question 14

Spreads =

Answer 14

Combination of two or more calls (or puts) on the same stock with differing exercise prices or times to maturity

Question 15

Bullish spread =

Answer 15

Investor thinks one option is overpriced relative to another. Way to profit from stock price increases > pay-off either increases or is unaffected

Question 16

Money spread =

Answer 16

Purchase one option and simultaneous sale of another with different exercise price

Question 17

Time spread =

Answer 17

Refers to sale and purchase of options with differing expiration dates

Question 18

Pay off =

Answer 18

Difference in value call held and value call written

Question 19

Collars =

Answer 19

Options strategy that brackets the value of portfolios between two bonds

Question 20

Collars limit downside risk by

Answer 20

Selling upside potential

Question 21

Collars > net outlay for options is approx zero if

Answer 21

Fund put purchase by writing covered call

Question 22

Collars are appropriate for investors who

Answer 22

Has a target wealth goal in mind but is unwilling to risk losses beyond a certain level

Question 23

Put-call parity =

Answer 23

Simultaneously holding a short European put and long European call of the same class will deliver the same return as holding one forward contract on the same underlying asset, with the same expiration, and a forward price equal to the option’s strike price

Question 24

Pay off to put-call parity portfolio =

Answer 24

Identical to pay off in protective put strategy

Question 25

Call plus bond portfolio must

Answer 25

Cost the same as the stock plus put portfolio

Question 26

To exploit mispricing

Answer 26

Buy cheap portfolio and sell expensive portfolio

Question 27

Put call parity can only exist

Answer 27

In European options, which must be exercised on expiration date (not American)

Question 28

Callable bonds =

Answer 28

Bonds issued with call provisions, which give issuer the right to buy bonds back from bondholders in the future at a specified call price

Question 29

Exercise price =

Answer 29

Repurchase price of bond

Question 30

Convertible securities =

Answer 30

Gives holder the right to exchange a bond/ share of preferred stock for a fixed number of shares of common stock regardless of the market price of the securities at the time

Question 31

Most convertible securities are issued ‘deep out of the money’:

Answer 31

Issuer sets a conversion ratio such that the conversion is not profitable unless there is a substantial increase in stock prices, or fall in bond prices

Question 32

Warrants =

Answer 32

Call options issued by a firm (can be tailored to meet the needs of the firm)

Question 33

Exercise of a warrant requires

Answer 33

A firm to issue a new share of stock

Question 34

Warrants result in

Answer 34

Cash flow to firm when warrant holder pays the exercise price

Question 35

Asian options =

Answer 35

Options with payoff that depends on the average price of underlying asset

Question 36

Barrier options (down and out)

Answer 36

Payoff depends on some barriers eg barrier price

Question 37

Lookback options

Answer 37

Payoff depends on a minimum/ maximum price of underlying asset

Question 38

Currency translated options

Answer 38

Have assets/ exercise prices denominated in foreign currency

Question 39

Digital options (binary)

Answer 39

Have fixed pay-offs that depend on whether the condition is satisfied by the price of the underlying assets