Options Flashcards
what are the two types of options
calls and puts
what is a call option
gives the holder the right but not the obligation to buy an asset on a certain date for a certain price
what is a put option
gives the holder the right but not the obligation to sell an asset on a certain date for a certain price
what must be specified in an option contract
- what you are buying or selling (the underlying)
- is it a call or a put
- whether you are buying or selling the option (long or short)
- when the asset can be bought or sold (Expiry date)
- at what price (strike price)
- the price of the option (option premium)
what is the strike price
the price at which it is agreed the asset will be bought or sold
what is the option premium
the money that changes hands when the option is agreed upon
what does the premium of the option depend on
where the strike price is in relation to the price of the underlying
if the strike price of a call is lower than the underlying price currently will the premium be higher or lower
higher
if the strike price of a put is higher than the underlying price currently will the premium be higher or lower
higher
if you are setting strike price for call option what is your goal
to buy as cheap as possible
so set as low as possible
if you are setting the strike price for a put option, what is your goal
to sell for as much as possible
so set as high as possible
if the option is at the money what does this mean
the strike price = forward price
if the option is in the money what does this mean
call : strike price is lower than the forward price (better off as you can buy more cheaply)
put : strike price is higher than the forward price (better off as you can sell for more money)
if an option is out of the money what does this mean
call : strike price is higher than the forward price (worse off as you must pay more)
put : strike price is lower than the forward price (Worse off as you must sell for less)
how does the option change in value throughout its lifetime
as the price of the underlying asset changes, the value of the option changes
do owners of call options want the price of the underlying to increase or decrease in order to profit
increase
do owners of put options want the price of the underlying to increase or decrease in order to profit
decrease
an example of when you would not exercise a call option
when the price of the underlying goes down and it is cheaper to buy it in the market
an example of when you would not exercise a put option
when the price of the underlying goes up and it is more profitable to sell at its current market price
what must also be taken into account when considering the profts
sunk cost from upfront premium payment
difference between option contracts and future/forward contracts
option = not obliged to exercise where as future/forward must be exercised
option = premium paid where as future/forward has no money changing hands initially
who gets to hold onto the premium if the option is not exercised
the seller
where is the kink point in an option contract diagram
strike price
which has limited upside: a put or call
put
because there is a limited maximum payout.
if the price goes down you make money. but if the price goes up, which can be infinite, you lose money
why does a call option have an unlimited upside
if the price goes down, you lose money
but if the price goes up, which it can infinitely, you are saving money
if you are a owner of a put option, and the prices go up, what do you wish you had
a forward contract
if you are the owner of a call and the prices go down, what do you wish you had
FORWARD
if you are bullish about the price of an asset, what could you do as an investor
buy it
buy forward/future on it
buy option on it
if you are bearish about the price of an asset, what could you do as an investor
short the asset
short the future
buy a put option
if you already own an asset and you are worried about it falling in price what could you do
sell it
short forward/future contract
buy put option
what is a protective put
like insuring an asset you own
you buy a put on an asset you think may fall in price
the cost of the insurance is the cost of the underlying
what is a covered call
selling a call option on stock you already own
it is a way to generate an income from an asset that you don’t think will go up in price
what is the risk with covered calls
if the price of the asset does go up, you give up the chance of the upside
what is a straddle
buying a combination of a put and a call on the same asset with the same strike price
if asset moves either way you profit
what is a straddle a trade on
volatiliry
example of when you would use a straddle
when the outcome is unknown
eg brexit
eg pharmaceutical drug test trial
if you want to short straddle what must you do
sell a call and put option with the same strike price
what is a short straddle a trade on
little to no volatility
