Novice Option Strategies

Question 1

Time value

Answer 1

The difference between an option’s premium and its intrinsic value

Question 2

Extrinsic value

Answer 2

The difference between an option’s market price and its intrinsic value

Question 3

Intrinsic value

Answer 3

The difference between the current market value of the underlying stock and the strike price of an option

Question 4

Covered call

Answer 4

• Long stock
• Short call
• Maximum profit = [(strike price – stock purchase price) x number of shares] + (option premium x number of option contracts x number of shares per contract)
• Maximum loss = (stock purchase price x number of shares) – (option premium x number of option contracts x number of shares)
• Break-even point = stock purchase price – option premium per share

Question 5

Covered call payoff diagram

Answer 5

Question 6

Married put

Answer 6

• Long put
• Long stock
• Maximum profit = [(current stock price – original purchase price) x number of shares] – (option premium paid x number of option contracts x number of shares)
• Maximum loss = [(strike price - current stock price) x number of shares] + (option premium x number of contracts x number of shares)
• Break-even point = purchase price + option premium paid per share

Question 7

Married put payoff diagram

Answer 7

Question 8

Vertical call

Answer 8

• Bull vertical call
  
  • Buy one call option on the underlying stock
  • Sell one call option on the same underlying stock with a higher strike price
• Bear vertical call
  
  • Buy one call option on the underlying stock
  • Sell one call option on the same underlying stock, with a strike price below the long call option

Question 9

Bull Vertical call

Answer 9

• Maximum profit = [(strike price of short call – strike price of long call)] x (number of contracts) x 100 – option premium paid
• Maximum loss = option premium paid
• Break-even point = strike price of long call + long call premium per share – short option premium per share

Question 10

Bull vertical call payoff diagram

Answer 10

Question 11

Bear Vertical call

Answer 11

• Maximum profit = (short option premium – long option premium) x number of contracts x 100
• Maximum loss = [(strike price of long call – strike price of short call) x number of contracts x 100] – NET option premium received
• Break-even point = strike price of short call + short option premium per share – long option premium per share

Question 12

Bear vertical call payoff diagram

Answer 12

Question 13

Vertical Put

Answer 13

• Bull vertical put
  
  • Buy one put option on the underlying stock
  • Sell one put option on the same underlying stock, with the same expiry date
• Bear vertical put
  
  • Buy one put option on the underlying stock
  • Sell one put option on the same underlying stock with the same expiry date

Question 14

Bull vertical put

Answer 14

• Maximum profit = option premium received – option premium paid
• Maximum loss = strike price of short put – strike price of long put – net option premium received
• Break-even point = strike price of short put – net option premium received per share

Question 15

Bull vertical put payoff diagram

Answer 15

Question 16

Bear vertical put

Answer 16

• Maximum profit = strike price of long put option – strike of short put option – option premium paid + option premium received
• Maximum loss = option premium paid – option premium received
• Break-even point = strike price of long put – option premium paid per share

Question 17

Bear vertical put payoff diagram

Answer 17