Options Flashcards

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1
Q

3 Reasons to invest in options

A

Hedging
Speculation
Income

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2
Q

Intrinsic Value of Call Option formula

A

Stock price - Strike price

Intrinsic value can NOT be less than 0

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3
Q

Intrinsic Value of Put Option

A

Strike Price - Stock Price

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4
Q

Time Value of an Option formula

A

Time Value =
Premium - Intrinsic Value

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5
Q

How to add Portfolio Insurance with Puts?

A

Using Put option on an index to “lock-in” portfolio gains

Typically when you have diversified portfolio and worried about market downturn

Buying puts on S&P500 will protect a well diverted portfolio

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6
Q

Long Straddles

A

Buy a Put and a Call

Expect volatility but not sure which direction

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7
Q

Short Straddle

A

You Sell a Put and Call

You don’t expect volatility, just hoping to keep the premiums

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8
Q

Black Scholes does what?

A

Determines value of a call option

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9
Q

Black Scholes uses what Variables?

A

Current price of stock
Time to expiration
Risk-Free rate
Volatility of stock
(All of above increase the value of call option as they get higher)

Strike Price
(Inversely related to value of option)

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10
Q

Put/Call Parity

A

To value a Put based on value of a Call

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11
Q

Binomial Pricing Model

A

Values an option based on assumption that stock can only move in one of two directions

Tree structure

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12
Q

Warrants

A

Essentially Call options issued by a corporation

Expiration is much longer than options, usually 5-10yrs (options are 9 months or less)

Warrant terms are NOT standardized

Used as sweeteners to a bond deal

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13
Q

Naked Call

A

Sell a call option on a stock I don’t own

Max Loss is Unlimited

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14
Q

Futures

A

Commodities (copper, wheat, oil, corn, pork)

Financial (currency, interest rates, stock indexes)

Obligate holder to make or take delivery of underlying asset

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15
Q

Process of Hedging a position with Futures

A

Long the commodity, Short the contract:

Orange grove owner knows the price he must receive to make profit, the future Orange price is unknown, but current price on contract for future delivery is known. You sell a contract for future delivery to lock in your sale price.

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16
Q

Process of Hedging using Futures: Short the Commodity, long the contract

A

Manufacturer of orange juice BUYS a futures contract on oranges and has a short position in the manufacturing costs of juice in the future.