Lesson 6: Options Flashcards
Call Option
Owner (buyer):
- right to buy at strike
- pay a premium
- bullish (want price to go up, option is exercised)
Writer (seller):
- obligated to sell at strike
- earn a premium
- bearish (want price to go down, option expires)
Both sides can trade the contract to exit the position
In the Money (ITM)
Options are ITM if they have intrinsic value
Calls: If the strike is lower than the market value (can you buy the asset for less than it’s worth)
Puts: If strike is higher than market value (you can sell the stock for more than it is worth)
ALWAYS exercised
At the Money (ATM)
Options are ATM if the strike equals the market value
Out of the Money (OTM)
Options are OTM if they have no intrinsic value
Calls: If the strike is higher than the market value
Puts: if the strike price is lower than the market value
ALWAYS expire
Put Option
Owner (Buyer)
- right to sell at strike
- pay a premium
- bearish (want the price to go down, contract exercises)
Writer (Seller):
- obligation to buy at strike
- paid a premium
- bullish (want price to go up, contract expires)
Both sides can trade the contract to exit the position
Protective Put
Buy put in combo with long stock position
This protects a long stock position because you always have the right to sell at k.
So if you long stock position goes to zero, the worst you can lose is -(prem + k)
In general: better protection against downside risk and unlimited upside potential (so worse for flat markets)
Short Stock Hedge
Buy call in combo with short stock position
Protects from the unlimited downside of the short position because you can always buy at the lower price
Covered Call
Sell call in combo with long stock position
In general: limited upside and significant downside risk (better returns in flat/slightly up markets)
Option Expiration
Always expire on the 3rd friday of the month
Standard contracts expire after issuance
American Option
Can be exercised at any time
Most common for equity options
Index options
Options that use the value of an index as the underlying asset
No physical settlement, all is settled in cash
Structured the exact same way as an equity option (so you can hedge a whole portfolio by hedging a single index option like the S&P500)
European Option
Can ONLY be exercised at expiration
Most common for index options
Equity Options
Actually settle with physical stock settlement
VIX
Volatility Market Index (fear index)
Measures the vol of S&P500 options
Inversely related to the market
Options Clearing Corporation (OCC)
The corporation that issues and guarantees options contracts
test point: if an investor wants to exercise an option contract, their BD would notify the OCC ,which assigns the contract to an appropriate counter party
Trading Options
Buy an option (pay a premium) then Sell the contract (new person collects the premium)
Sell an option (earn premium) then buy an option to pay premium)
