Options

Question 1

What are options?

Answer 1

An option gives the holder the right, but not the obligation, to buy or sell a given quantity of an asset on (or before) a given date, at prices agreed upon today.
Exercising the Option
The act of buying or selling the underlying asset
Strike Price or Exercise Price (ST)
Refers to the fixed price in the option contract at which the holder can buy or sell the underlying asset.
Expiry (Expiration Date- E)
The maturity date of the option

Question 2

What is the difference between European vs American?

Answer 2

European options can be exercised only at expiry.
American options can be exercised at any time up to expiry.
In-the-Money
Exercising the option would result in a positive payoff.
At-the-Money
Exercising the option would result in a zero payoff (i.e., exercise price equal to spot price).
Out-of-the-Money
Exercising the option would result in a negative payoff.

Question 3

What are call options?

Answer 3

Call options gives the holder the right, but not the obligation, to buy a given quantity of some asset on or before some time in the future, at prices agreed upon today.
When exercising a call option, you “call in” the asset.

Question 4

What are call options expiry?

Answer 4

At expiry, an American call option is worth the same as a European option with the same characteristics.
If the call is in-the-money, it is worth ST – E.
If the call is out-of-the-money, it is worthless:
C = Max[ST – E, 0]
Where
ST is the value of the stock at expiry (time T)
E is the exercise price.
C is the value of the call option at expiry

Question 5

What are put options?

Answer 5

Put options gives the holder the right, but not the obligation, to sell a given quantity of an asset on or before some time in the future, at prices agreed upon today.
When exercising a put, you “put” the asset to someone.

Question 6

What are put options expiry?

Answer 6

At expiry, an American put option is worth the same as a European option with the same characteristics.
If the put is in-the-money, it is worth E – ST.
If the put is out-of-the-money, it is worthless.
P = Max[E – ST, 0]

Question 7

What are option values?

Answer 7

Intrinsic Value
Call: Max[ST – E, 0]
Put: Max[E – ST , 0]
Speculative Value
The difference between the option premium and the intrinsic value of the option.

Question 8

What are option positions?

Answer 8

The seller (or writer) of an option has an obligation.
The seller receives the option premium in exchange.
takes the long position and has the right but not the obligation to exercise the option if it is in the money
The counterparty is the option writer who takes the short position; if the option owner exercised the option, it would be exercised against the writer who would have to sell the underlying asset to the holder of the call option for the strike price (even though the strike would be less than the market value of the underlying asset if the option were in the money