Options Flashcards
What’s the moneyness?
The potential profit or loss if the option is exercised immediately.
What’s the Intrinsic Value of a call option?
Intrinsic Value = Current Market Price - Option Stike Price
What’s the Intrinsic Value of put option?
Intrinsic Value = Strike Price - Current Market Price
What’s the impact of following factors on Option Price?
1) Price of underlying share
2) Exercise Price
3) Time to expiration
4) Volatility of underlying share
5) Risk-free interest rate
6) Expected dividends
What’s the payoff of an option holder?
Payoff is the gain before deducting the option price or premium
The call option writer breaks even if ______
The underlying price moves above the exercise price by an amount equal to the option price.
The breakeven point for _____ is the same.
Call option buyer and writer
Put option buyer and writer
The breakeven poitn for call option buyer and writer is _____
The same
If the underlying price moves above the exercise price by an amount equal to the option price
The put option writer breakeven if ____
If the price of the underlying falls below the exercise price by an amount that is equal to the premium received
What’s Put-Call Parity Theory Formula?
C + PV (X) = p + S
Current price (market value) of the European Call + Present Value of the strike price of the European Call discounted from the expiration date at risk-free rate = Current price (market value) of the European Put + Current market value of the underlying share
Esentially, a portoflio of a call option and cash equal to the present value of the option’s strike price, has the same expiration value as a portfolio comprising of the corresponding put option and the underlying share.
How to use the Put-Call Parity Theory to create sysnthetic securities, i.e.
A synthetic bond
A synthetic share
A synthetic bond: PV (X) = p + s - c
A synthetic share: s = PV (x) + c - p
What’s the underlying presumptions to use Call-Put Parity Theory to create synthetic securities? (3)
There’re no dividends
Strike prices for calls and puts are the same
The number of shares of stock are equal to the number of shares represented by the options
What’s a synthetic long stock?
This’s a ____ alternative to _____
Long at-the-money call + Short at-the-money put with the same expiration date creates a synthetic long in a stock.
Low cost alternative to purchasing the share
What’s a synthetic short position?
Shorting at-the-money calls and buying a an equal number of at-the-money puts on the underlying share, having the same expiration date.
What’s synthetic Long Call / Long Put / Short Call / Short Put?
Long Call = Long underlying + Long Put
Long Put = Short underlying + Long Call
Short Call = Short underlying + Short Put
Short Put = Short Underlying + Short Call
In the Black-Scholes formula, the value of an option is determined by ___ factors.
which are ___
Six
Underlying share price
Strike price
Time to expiration
Implied volatility
Dividend status
Interest rates
What’s the Volaitility Greeks?
The Greeks are a collection of statistical values that give investors an overall view of what drives option premiums and the changes in pricing model inputs.
What are the 5 Greeks and their formula?
- Delta: Major sensitivity measure, represents the first-order relationship between the option price and the underlying price.
Delta = Change in option price / Change in underlying price
- Gamma: Gamma is the sensitivity of delta to changes in the underlying asset price. So it’s a second-order relationship between option price and the underlying asset price.
Gamma = 2V/S2
- Vega is the relationship or sensitivity of the option price with its volatility.
- Theta represents the sensitivity of the option price to the time to expiration. The option’s theta is the rate of time value decay.
- Rho: sensitivity of the option price to the risk-free rate.
The delta of the call option is between ___ and ___.
0 and 1
If gamma is large, delta changes ____ and ____ estimation of sensitivity to changes in the underlying asset price.
Fast
does not provide a good
Gamma is usually large when the option is ____ and _____
the option is at-the-money and close to expiration
Under what situation, delta hedges work poorly?
When the option is at-the-money and close to expiration
When Gamma is large
What’s the volatility of the underlying asset?
Standard Deviation of the continuously compounded return on the underlying asset
Vega is larger when the option _______
the option approaches being at-the-money
Vega are ___ for call and put option because ____
Positive
Volatility increases the price of both calls and puts
Theta of call / put option is ____
always negative
What’s the risk-free rate in Rho?
Continuously compounding rate of return on the risk free security whose maturity corresponds to the life of the option
Calls have a ____ correlation with the risk-free rate
Puts have a ____ correlation with the risk-free rate
Positive
Negative
____ style options are not very sensitive to risk free rate.
European style
If a short put position is combined with the purchase of a fixed rate note, the yield of the note is ____
Increased
What’s a yield enhancement strategy?
Short a put + Buy a fixed rate note
The yield of the note is enhanced
What’s a bull equity-linked note?
Structuring a fixed income instrument with an embedded short
What is a straddle option strategy?
Involve simultaneously purchase of both an ATM call and an ATM put
What’s the downside of a strangle option strategy? When it happens?
The downside is limited to the sum of the premiums paid.
This happens if the stock price remains between the strike prices of the options that are purchased.
What’s an option spread?
Option spread involves simultaenous purchase and sale of options of the same class on the same underlying security.
However the strike prices and / or the expiration dates are different.
Spreads _____ the net cost of buying an option.
Reduce
A naked option seller using spreads to _____
lowers margin requirements
What’s a bull call spread?
What’s the upside/downside?
What’s the maximum gain/loss?
When loss occurs?
What’s the market view?
A bull call spread is a vertical spread created by buying an in-the-money call option while simultaneously selling a higher striking out-of-the money call opion.
The underlying security and the expiration month are the same.
Upside is limited, and the maximum gain is acheived when the share price moves above the higher strike price of the two calls.
The gain is equal to the difference between the strike prices of the two call options minus the initial debit.
Downside is also limited and loss occurs if the underlying declines.
Bullish market view
What’s a Bull Put Spread?
What’s upside / downside?
When loss occurs?
What’s the market view?
Selling a higher striking in-the-money put option and buying a lower striking out-of-the money put option.
Upside is limited to the initial credit. The options expire worthless if the share price closes above the higher strike price on expiry.
Downside is also limited to the difference between the strike prices of the two puts minus the net credit received.
Loss occurs if the share price drops below the lower strike price on expiration date.
Market view: The options trader thinks that the price of the underlying asset rise moderately in the short-term.
What’s a Bear Call Spread?
What’s upside / downside?
When loss occurs?
What’s the market view?
Buying call options of a certain strike price and selling the same number of call options of lower strike price on the same underlying and expiry.
Upside is limited to the initial credit received. For this to occur, the share price must close below the strike price of the lower striking call sold at expiration date. Here, both options expire wortheless.
Downside: Maximum loss occurs when the share price rises above the stike price of the higher strike call at the expiration date.
The maximum downside is equal to the difference in strike prices between the two options minus the initial credit.
Market view: The price of the underlying asset will go down moderately.
What’s a Bear Put Spread?
What’s upside / downside?
When loss occurs?
What’s the market view?
Buying a higher striking in-the-money put option and selling a lower striking out-of-the money put.
Upside: If the underlying closes below the strike price of the out-of-the money puts on expiry, maximum profit is earned.
The maximum profit is equal to the difference in strike prices minus the debit taken when the position was entered.
Downside is maxi mum if the share price rises above the in-the-money put option strike price on expiry. The entire initial debit is lost.
Market view: The trader reduce the cost of establishing the bearish position by shorting the OTM put, but gives up the chance of making a huge profit if the underlying falls significantly.
What’s a Butterfly Spread?
A bull spread + A bear spread
Buy 1 ITM option Sell 2 ATM option and Buy 1 OTM option.
There’re 3 strike prices involved.
What’re Long Call Butterfuly Spread and Long Put Butterfuly Spread? When investors use these strategies?
What’s the maximum loss?
Investors take long butterfly call or put spread positions if they do not expect much movement in the underlying till expiry.
The maximum loss is limited to the initial debit.
What’s vertical spreads?
Options of the same class, same underlying security, same expiration month but having different strike prices
Horizontal or calendar spreads?
Involve options of the same underlying, same strike prices but with different expiration dates.
What’s the horizontal/calendar spreads used by trader if he expects the volatility to increase?
Sell_____options and buy _____ options
Sell short-dated options and buy long-dated ones
Diagonal spreads?
Involve options of the same underlying security but different strike prices and expiration dates.
Condor Spread?
A condor spread is a variation of the butterfly spread as it involves 4 options.
However, all 4 options have different strike prices, whereas there’re three strike prices in a butterfly spread.
The range of strike price of Condor Spread is ____ compared to Butterfly Spread.
Wider
What’s a market neutral option strategy where the expected volatility is low?
Ratio Spread
What’s the upside/downside of ratio spread?
Upside is limited
Downside is unlimited
All option contracts on SGX are _____
American style futures options
What’s the option strategy taken by a hedger who wants to take on a very limited risk exposure?
Zero-Cost option, which involves buying an option and selling another
A collar is established by _____
Buying a protective put while writing an out-of-the-money covered call.
What’s a cash extraction strategy?
An option can also be used as part of a cash extraction strategy when the investor, who has the underlying asset and needs cash, sells it and buys call options to maintain upside exposure to the underlying asset.
What’s the option strategy to use if someone expects a big move in a stock but unsure of the direction?
Long Bull Straddle: BUY both the call and the put (at-the-money or in-the-money)
What’s the option strategy to use if someone expects little move in a stock but unsure of the direction?
Short (Bear) Straddle: Sell both the ATM call and ATM put, hoping that both the options will expire worthless.
What’s the call/put option for a bull view (directional) on stock price?
Buy a call + Sell a put
What’s the call/put option for a bearish view (directional) on stock price?
Sell a call + buy a put
What’s the theta for a long straddle (bull) strategy?
Theta is negative because there’re two long option positions (option time value will decay over time)
What are neutral market outlook strategies?
Straddles
Covered Call
A strangle is also known as the ____ .
It involves ________
A strangle is also known as the long strangle.
It involves simultaneously BUY a slightly OTM call and BUY a slightly OTM put of the same underlying stock and expiration date.
A strangle strategy is ____ compared to a straddle strategy because ____
Less costly
because two OTM options are used. (OTM options will have a relatively lower premium compared to ATM)
In a strangle strategy, the strike price of the call option would be ____ compared to the strike price of the put option.
Higher
Since the put is also OTM, the strike price will be lower than that of the OTM call.
What’s debit bull vs. credit bull?
Debit Bull = Bull Call Spread
Credit Bull = Bull Put Spread
In the case of calendar spread, the ____ option is bought and the ____ option is sold in case _____
Short-dated
Long-dated
volatility is expected to decline
A call option on USD at a strike price of AUD 1.35 will help the investor ____
The option will give the investor the right to _____
If USD appreciates, the value of the call option will _____
Gain from any appreciation in USD or depreciation in AUD.
Buy USD at 1.35 AUD per USD.
Increase
Selling a put option on USD with AUD 1.35 strike price will also help the investor _____
Make a profit equal to the premium pocketed
A collar is established by _____
A zero-cost collar is named for ____
Buying a protective put while write a OTM covered call.
The call option is sold with a strike price where the premium received is equal to the premium paid for the put purchased
Time value is the lowest at ____
Expiry
Time value = _____ for ATM (or OTM) options and why?
Option price for ATM (or OTM) options as the intrinsic value of ATM or OTM options is zero
Time Value = Option price - Intrinsic Value
Higher volatility may ____ the time value because _____
Increase
Because the chance of the option becoming ITM (or deeper ITM) increases
Time value decays ____ when the time to expiry draws near
faster
The profits made by the call option writer are ____ the loss suffered by the holder.
equal to
What’s the intrinsic value of a call option?
Market Price - Strike Price
Futures price and option price are ____ correlated for CALLS
Positively
Futures price and options price are positively correlated for ____
Calls
Binomial model is more suitable for _____ options as it _____
American
Incorporate the early exsercise future
The price of an option cannot be _____
Negative
If the risk is zero, the price of the option can be _____ depending on _____
Zero depending upon the strike price and the underlying price
Only ___ options have positive delta.
Call
If the delta of a long option position is 0.4. A $1 rise in the underlying asset will lead to ____ in the ____ option price.
40 cents increase in the call option price
delta = 0.40 = $0.40/$1.0
If a graph between the gamma of an option (vertical-axis) and its underlying share price (horizontal-axis) is plotted, it shape will approximately be _____
Bell-shaped curve with gamma being the highest for ATM strike price
Theta is the quantitative measure of the rate at which _____
The quantitative measure of the rate at which the time value of an option is eroded.
Theta is ____ for both long call and long put positions
Negative
Vega indicates _____
An absolute change in option value for 1% change in volatility.
Vega is larger as the option ____.
closer to being ATM
Vega for both call and put options are _____ because ___
Positive
Increased volatility leads to higher option price
Vega is measured by _____
The change in value of an option , i.e. the premium over a 1% change in market volatility
RHO is ____
The continuously compounding rate of return on the risk free security whose maturity corresponds to the option’s life.
Option Price =
Intrinsic Value + Time Value
Breakeven point for a call buyer =
Beakeven point for a call writer =
Breakeven point for a put buyer =
Breakeven point for a put writer =
Strike price + premium paid
Strike price + premium received
Strike price - premium paid
Strike price - premium received
