Option Hedging, Speclation, Spreading

Question 1

What is the relationship between

“Interest Rates” and “ Future Options”?

Answer 1

Note: (cash1)(rate1)=(cash2)(rate2)

1. To hedge against rising interest rates; buy puts
2. To hedge against falling interest rates; buy calls

Question 2

When HEDGING with options;

How is the “breakeven point” for a long call calculated

How is the “breakeven point” for a long put calculated

Answer 2

Long Call breakeven
=Strike price of call($/unit) + premium paid($/unit) + commission/unit($/unit)

Long Put breakeven
= strike price of put -premium paid -commission/unit

Question 3

What’s the general equation for “synthetic positions”?

Answer 3

Long futures(+) = short put(+) + long call(+)

Question 4

Define the following “synthetic positions”:

1. Long futures
2. Short futures
3. Long put
4. Short put
5. Long call
6. Short call

Answer 4

1. Short put(+) + long call(+)
2. Long put(-) + short call(-)
3. Short futures(-) + long call(+)
4. Long futures(+) + short call(-)
5. Long futures(+) + long put(-)
6. Short futures(-) + short put(+)

Question 5

When SPECULATING with futures options;

How is the breakeven point for a long options position (call or put) calculated?

Answer 5

Premium paid($/unit) + commission/unit($/unit)

Question 6

DELTA
1. How is delta calculated?

2. If you long call or short put, is the futures bought or sold to balance delta?
3. If you short call or long put, is the futures bought or sold to balance delta?

Answer 6

1. # futures contracts / #options contracts
2. Sell futures
3. Buy futures

Question 7

Define the following factors
1. Beta

2. Conversion factor
3. Delta

Answer 7

1. Individual stocks or portfolios vs stock index
2. Individual T-bonds vs deliverable T-bonds
3. Futures prices vs option premiums

Question 8

Define a “ Covered Short Call” aka Buy-and-Write;

Meaning the writer buys futures and sells call

Answer 8

1. The option writer holds a long futures position!
2. If exercised, the writer delivers the long futures to the call holder, thereby offsetting his long futures position
3. The call holder is now long futures or offsets an existing short futures position

Question 9

Define an “Uncovered Short Call” aka an uncovered written call

Answer 9

1. The option writer does not have a long futures position!
2. If exercised, the writer delivers a long futures to the call holder, thereby establishing a short futures position in his own account
3. The call holder is now long the futures or offsets an existing short position.

Question 10

Define a “Covered Short Put” aka Sell-and-Write

Meaning the writer sells futures and sells put

Answer 10

1. The put writer is short the futures
2. If exercised, the writer acquires a long futures position from the put holder, thereby offsetting his existing short futures position
3. The put holder is now short futures or offsets an existing long futures.

Question 11

Define an “ Uncovered Short Put” aka an uncovered written put

Answer 11

1. The put writer does not hold a short futures position
2. If exercised, the writer buys futures from the put holder, thereby establishing a long futures position
3. The put holder is now short futures or offsets an existing long futures position

Question 12

Name and define the three types of “ Option Spreads”

Note: think of a chart of “expiration date” vs “strike price”

Answer 12

1. Vertical or price spreads
   - > same expiration dates but different strike price
2. Horizontal or calendar spreads
   - > same strike price but different expiration dates
3. Diagonal or Arbitrage spreads
   - > both different strike price and expiration dates

Question 13

Name and define the types of “Vertical Spreads”

Answer 13

1. Bull call spreads
2. Bear call spreads
3. Bull put spreads
4. Bear put spreads

1,3-> buy low strike price option and sell high strike price option

2,4-> sell low strike price option and buy high strike price option

Question 14

Regarding the different types of vertical spreads, describe the following;

1. The price expectation; Increasing or decreasing
2. The corresponding spread response; narrowing or widening

Answer 14

1. Bull call spread
   - > expecting a price increase
   - > resulting in a widening spread
2. Bear call spread
   - > expecting a price decrease
   - > resulting in a narrowing spread
3. Bull put spread
   - > expecting a price increase
   - > resulting in a narrowing spread
4. Bear put spread
   - >expecting a price decrease
   - > resulting in a widening spread

Question 15

1. Define a “Butterfly Call Spread”

2. Define a “Butterfly Put Spread”

Answer 15

1. Buy ONE at-the-money call
   Sell TWO out-of-the-money calls
   Buy ONE out-of-the-money call
2. Buy ONE at-the-money put
   Sell TWO out of the money puts
   Buy ONE out of the money put

Question 16

Define a “Short Straddle”

Define a “Long Straddle”

Answer 16

1. Used when prices are expected to be flat
   - >Short a call and short a put of the same strike price and expiration
2. Used when prices are expected to be volatile
   - >Long a call and Long a put of the same strike price and expiration

Question 17

Define a Strangle

Answer 17

Sell one out-of-the-money call and sell one out-of-the-money put