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International Financial Markets > Options > Flashcards

Options Flashcards

1
Q

What are options?

A
  • right to buy or sell something (counterparty has the obligation to do the opposite)
  • at a predetermined price (strike price/exercise price)
  • within a specified timeframe
  • the right is granted by the option writer to the option buyer
  • for a certain fee (option premium)
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2
Q

What is a call option?

A

The right to buy

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3
Q

What is a put option?

A

The right to sell

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4
Q

What does S symbolise?

A

The share price

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5
Q

What does X symbolise?

A

The exercise price

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6
Q

What is the role of the writer?

A

The writer (seller) receives 0.50 (premium), sits & waits

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7
Q

What is the role of the buyer?

A

The buyer pays 0.50 (the premium) and can:
1. sell the option to other investors on an option exchange
2. exercise the option

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8
Q

What effect does stock price have on the premium of an option?

A

The premium of call options moves in the same direction as the underlying asset, while the premium of the put option moves in the opposite direction.

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9
Q

What happens when the stock price goes up?

A
  • premium of call goes up
  • premium of put goes down
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10
Q

What happens with the option premium when the stock price goes down?

A
  • premium of call goes down
  • premium of put goes up
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11
Q

What is the gain/loss at expiration?

A

It is a zero sum game, the gain for the buyer = loss for the writer
Gain = pay off - option premium

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12
Q

When is an option at the money?

A

Both call and put are atm when S=X

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13
Q

When is a call in the money?

A

S > X

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14
Q

When is a call out of the money?

A

S < X

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15
Q

When is a put in the money?

A

S < X

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16
Q

When is a put out of the money?

A

S > X

17
Q

Percentage returns

A

gain or loss / how much I paid (premium)

18
Q

Are options a risky investment?

A
  • buying options is risky as there is high volatility of return
  • writing options is risky as the gain is limited (max premium), but the loss depends on the share price at the moment (unlimited)
19
Q

What is the difference between a naked and a covered call?

A

Covered - as the option writer you already own the underlying asset
Naked - you don’t yet own the stocks

20
Q

What is the value of an option?

A
  • total price of the contract is = premium
  • the option has intrinsic value and time value
21
Q

What is intrinsic value?

A
  • How valuable is it to exercise the option?
  • Can never be negative (min = 0)
  • Usually option premium > IV
22
Q

How do we calculate IV of a call?

A

S - X (min = 0)

23
Q

How do we calculate IV of a put?

A

X - S (min = 0)

24
Q

What is the time value of an option?

A

More time to expiration makes the option more valuable

25
Q

How do we calculate TV?

A

TV = premium - IV

26
Q

What is the IV of a call and put when S=X?

A

call - IV = 0
put - IV = 0

27
Q

What is the IV of a call and put when S > X?

A

call - IV > 0
put - IV = 0

28
Q

What is the IV of a call and put when S < X?

A

call - IV = 0
put - IV > 0

29
Q

What is the relationship between the value of a call option and S & X?

A
  • higher S - higher option value
  • higher X - lower option value
30
Q

What is the relationship between the value of a put option and S & X?

A
  • higher S - lower option value
  • higher X - higher option value
31
Q

What role does volatility of the shares have in options?

A
  • higher volatility, higher chance of the option becoming in the money
  • the TV of an option will be bigger when volatility of share price is bigger
32
Q

What is the influence of share price on option value?

A

Call - positive
Put - negative

33
Q

What is the influence of exercise price on option value?

A

Call - negative
Put - positive

34
Q

What is the influence of time to expiration on option value?

A

Call - positive
Put - positive

35
Q

What is the influence of volatility of share price on option value?

A

Call - positive
Put - positive

36
Q

What is the influence of interest rates on option value?

A

Call - positive
Put - negative

37
Q

What are American options?

A

Can be exercised at any moment

38
Q

What are European options?

A

Can only be exercised at maturity

39
Q

Should you exercise before maturity?

A

By exercising before maturity, you give away the time value. If you want to get out it’s better to sell the option.

International Financial Markets (9 decks)

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