Lecture 7 Option Strategies & Valuation Flashcards
Options Specifics
Define options and distinguish between a European and American option
A call (put) option gives its owner the right to buy (sell) stock at a specified
exercise or strike price (K) on or before a specified maturity date (T)
European options are exercised only at maturity; American options can be
exercised on or at any time before maturity
Profit Formula for Options
What are the profit formulas for long and short call and put options?
Long and Short on Call and Put Options
Outline differences in being long and short on a call/put option
Call = Buy: Think “Call to Buy.”
Put = Sell: Think “Put it down (sell it).”
Long = You Buy the Right: You pay a premium for a right (call or put).
Short = You Sell the Right: You receive a premium but take on an obligation.
Popular Option Strategies I
Please outline:
Covered call strategy
Covered call strategy:
This strategy involves buying the underlying stock and simultaneously selling a call option on the same stock. This is done to generate income from the premium of the call option while holding the stock
- Neutral to Slightly Bullish Market:
You believe the stock price will stay the same or rise slightly but not exceed the strike price. - Income Generation:
You want to earn additional income from the option premium while holding the stock.
Popular Option Strategies II
Please outline straddle and butterfly spread
Straddle: Simultaneously buying a call option and a put option with the same strike price and expiration date. To profit from significant price movements in either direction (volatility).
Butterfly spread: Buying two options with the same expiration date but different strike prices (K1 and K3) and selling two options with a strike price in the middle K2, where K2 = (K1+K3)/2
Put-Call Parity
Please list and explain the formulas for put-call parity options (European, American & dividend-paying)
European:
P+S = C+K * Exp(-rfT)
American:
P+S = C+K * Exp(-rfT) + E
Dividend paying:
P+S * exp(-qT) = C+K * Exp(-rfT)
Determinants of Option Prices
What are the determinants of option prices?
Please find the expected value today of the following call
Black-Scholes Formula
Write the Black-Scholes pricing formula for a call option.
Question
Consider a 1-year European call option with a strike price of $90
written on a non-dividend-paying stock whose current price is $90.
Suppose that at the end of year 1 the stock price either increases to
$110 or decreases to $70. The annual risk-free interest rate is 9%.
What is the price of this option?
Price of Call in BS Model
Find the price of the call according to Black-Scholes using the following data:
Stock price (S0) = 100
Strike Price (K) = $105
Time to Maturity (T) = 1 year
Risk-free rate = 0.05
Volatility = 0.20
Show all steps:
C0 = $7.97
Binomial Tree
What is the formula for p (risk-neutral outcome) when solving the binomial tree?
Greeks in Options
What are the Greeks?
Naked Put
What is naked Put?
A naked put is an options strategy where the seller (writer) of the put option does not own enough cash or equivalent assets to buy the underlying stock if the option is exercised. This makes it a risky strategy because the seller is obligated to buy the stock if the buyer exercises the put, regardless of the stock price.
