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Bus 316 > Option Strategies > Flashcards

Option Strategies Flashcards

1
Q

What are option strategies

A

Option strategies are the simultaneous, and often mixed, buying or selling of one or more options that differ in one or more of the options’ variables. Call options, simply known as Calls, give the buyer a right to buy a particular stock at that option’s strike price.

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2
Q

What are the components of option strategies

A

Portfolios that involve underlying asset, riskless asset and options on the underlying asset

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3
Q

Who uses option strategies

A

Speculators and hedgers

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4
Q

Why do speculators and hedgers go through option strategies?

A

To achieve a desired position at option expiration time as a function of the value of the underlying asset

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5
Q

What are the three alternative classes of strategies

A
  1. Take a position in the option and underlying
  2. Take a position in 2 or more. options of the same type
  3. Combination: Take a position in a mixture of calls and puts
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6
Q

How are strategies analyzed?

A

Profit Diagrams

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7
Q

What does profit diagram visualize?

A

A plot of the profit arises from the strategy as a function of the value of the underlying asset at option expiration

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8
Q

What are the steps to creating a profit diagram?

A
  1. Plot the payoff strategy
  2. Subtract the necessary initial investment which can be negative
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9
Q

What is the covered call strategy

A

When you have a long position in the stock + short position in a call option

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10
Q

Why was the covered call strategy adopted?

A

This strategy is adopted when we want to sell the stock as soon as it goes above a certain limit price

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11
Q

Why is the covered call strategy a good strategy

A

Writing a call with a strike price at or above the lim guarantees a sale and option premium as

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12
Q

What is protective put strategy

A

When you take a long position in the stock plus a long position in a put option

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13
Q

Why is the protective put strategy adopted

A

Ensures that the value of our stock holdings does not fall below a certain limit price

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14
Q

Why is protective put strategy a good strategy

A

Buying a put with a strike price at or above the limit guarantees ( at the expense of the put option premium) that our wealth will always be at least equal to the strike price minus the premium and have the basis of portfolio insurance

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15
Q

How does the covered call look like?

A
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16
Q

What is bull spread with calls?

A

Buy a call with Strike price X1 and write a call with a strike price where X2>X1

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17
Q

What are the benefits of bull spreads?

A

Brings positive returns whenever the underlying goes up, with low initial investment and limits on both earnings and losses

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18
Q

What is a bear spread

A

When you buy the call with a high strike price, write a call with a low strike price

19
Q

What happens during a bear spread

A

Initial investment is negative therefore we receive money and we realize gains if the underlying goes down

20
Q

What are butterfly spreads

A
  1. Involve both call or put options
  2. They are low cost investments that bring money if the underlying asset has values in a narrow interval
21
Q

What usually happens in a butterfly spread

A

Potential gains and potential losses are limited

22
Q

How does the butterfly spread work?

A

Buy 1 call with strike price X1 and 1 call with strike price X3, write two calls with strike price X2, X2-X1=X3-X2

23
Q

What are calendar spread strategy

A

This is a strategy that involves two call options with the same strike price X but with different expiration dates

24
Q

How does the calendar spread strategy work

A

Involves buying the (more expensive) option with the longer expiration date and writing the option with the shorter expiration date

25
Q

What does the calendar spread strategy diagram show

A

This show the wealth at the maturity of the short option when it is assumed that the long option is sold

26
Q

What is the result of the calendar spread

A

This makes money if the stock price is near the strike price and loses if its too above or below the strike price

27
Q

What are the different types of combinations

A

Straddles, strangles, strips and straps

28
Q

What do the combination strategies involve

A

Puts and calls

29
Q

What are the results of the combination strategies

A

They make money if the underlying asset goes up or does substantially above or below the strike price of the options

30
Q

When are combination strategies suited

A

When making money from an event, that is going to affect the price of the underlying asset with an unknown outcome

31
Q

What is a straddle

A

Purchasing a put and a call with the same strike price and expiration date

32
Q

What is a strip

A

A long position in one call and two puts with the same strike price and expiration date

33
Q

What is a strap

A

A long position in two calls and one put with the same strike price

34
Q

What is protective put

A

This consists of a long position in a put option combines with a long position in the underlying shares

35
Q

What position in call options is equivalent to a protective put

A

It is equivalent to a long position in a call option plus cash and follows the put call parity

36
Q

What are two ways to create a bear spread

A
  1. Using two call options with the same maturity and different strike prices. Here the investor shorts the call option with the lower strike price and buys the call option with the higher strike price
  2. Using two put options with the same maturity and different strike price where the investor shorts the put option with the lower strike price and buys the put option with a higher strike price
37
Q

When is it appropriate for an investor to buy a butterfly spread

A

The butterfly spread involves three different strike prices (K1,K2,K3). This is should be purchased when the price of the underlying asset will stay close to K2

38
Q

What is the volatility

A

This is the standard deviation of the continuously compounded rate of return in one year.

39
Q

What are the concepts of underlying black scholes

A
  1. The option price and stock price depend on the same underlying source of uncertainty
  2. Form a portfolio consisting of the stock and the option which eliminates the source of uncertainty
  3. Portfolio is instantaneously riskless and must instantaneously earn the risk free rate
40
Q

What are the properties of the differential equation

A

Any security whose price is dependent on the stock price satisfies the differential equation and being valued is determined by the boundary conditions of the differential equation

41
Q

What is the boundary condition for a forward contract

A

f = S-K when t=T

42
Q

What is the solution to f=S-K when t=T

A

f=S-Ke^-r(T-t)

43
Q

What are the properties of the black Scholes formula

A
  1. So becomes very large CALLs tends to = So-Ke^rt and p = 0
  2. As So becomes very small, c tends to zero and p tends to Ke^-rt-So

Bus 316 (2 decks)

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