Options Flashcards
This deck focuses on the options market, including basic terminology, options strategies, and options trading.
1
Q
Regular way settlement for listed option contracts
A
T + 1
2
Q
Two types of options contracts
A
Calls and Puts
3
Q
All options of a single issuer with the same class, exercise price and expiration month
A
Series
4
Q
Options that can be exercised any time before contract expiration
A
American Style
5
Q
Options that can be exercised only on the business day preceding expiration
A
European style
6
Q
Number of shares within one standard option contract
A
100
7
Q
Has rights in an option contact
A
Holder (Buyer)
8
Q
Has Obligations at contract exercise
A
Writer (Seller)
9
Q
Right of a call buyer at contract exercise
A
Right to buy stock at exercise price
10
Q
Obligation of a call writer at contract exercise
A
Obligation to sell stock at exercise price
11
Q
Right of a put buyer at contract exercise
A
Right to sell stock at exercise price
12
Q
Obligation of a put writer at contract exercise
A
Obligation to buy stock at exercise price
13
Q
Market attitude of a call buyer
A
Bullish
14
Q
Market attitude of a call writer
A
Bearish
15
Q
Market attitude of a put buyer
A
Bearish
16
Q
Market attitude of a put writer
A
Bullish
17
Q
When a call is in the money
A
Market price exceeds strike price
18
Q
When a put is in the money
A
Market price is less than strike price
19
Q
Breakeven for a call
A
Strike price + premium
20
Q
Breakeven for a put
A
Strike price - premium
21
Q
Breakeven point for: Short ABC Jan 50 put for 3
A
47
22
Q
Breakeven point for: Long ABC Jan 50 put for 3
A
47
23
Q
Breakeven point for: Short ABC Jan 50 call for 3
A
53
24
Q
Breakeven point for Long ABC Jan 50 call for 3
A
53
25
Intrinsic value for: Long XYZ Jan 50 call for 3; XYZ is 52
2
26
Intrinsic value for: Short XYZ Jan 50 call for 3; XYZ is 52
2
27
Intrinsic value for: Long XYZ Jan 50 put for 3; XYZ is 49
1
28
Intrinsic value for: Short XYZ Jan 45 call for 4; XYZ is 48
3
29
The time value of an XYZ 50 call for 3 when XYZ is 49
3
30
The time value of an XYZ 50 call for 3 when XYZ is 52
1
31
The time value of an XYZ 30 put for 6 when XYZ is 26
2
32
The time value of an XYZ 30 put for 6 when XYZ is 32
6
33
Two factors that determine the premium of an option contract
Time value and Intrinsic value
34
Maximum gain for a long call
Unlimited
35
Maximum gain for a short call
Premium
36
Maximum gain for a long put
Strike price - premium
37
Maximum gain for a short put
Premium
38
Maximum loss for a call buyer
Premium
39
Maximum loss for an uncovered call writer
Unlimited
40
Maximum loss for a put buyer
Premium
41
Maximum loss for a put writer
Strike price - premium
42
Closing transaction for a put writer
buy a put
43
The use of options to protect a stock position
Hedging
44
Option position that provides full protection for a long stock position
Long put
45
Option position that provides full protection for a short stock position
Long call
46
Option position that provides partial protection and generates income for a long stock position
Short call
47
Option position that provides partial protection for a short stock position
Short put
48
Selling calls when holding a long stock position
Covered call writing
49
Type of option frequently used as portfolio insurance
Index option puts
50
When equity option contracts settle
Next business day (T + 1)
51
When index option contracts settle
Next business day (T + 1)
52
Expiration of index options
Third Friday of expiration month
53
Expiration of equity options
Third Friday of the month at 11:59 p.m.
54
When stock must be delivered as a result of equity option exercise
T + 2 (regular way settlement)
55
Equity option contracts with long-term maturities
LEAPS
56
Clearing agent for listed option contracts; issues and guarantees all listed option contracts
Options Clearing Corporation (OCC)
57
Length of a standard option contract
9 months
58
American-style option
A type of options contract that can be exercised by the buyer at any point prior to expiration. Most equity-based options are American-style.
59
at-the-money
A term used to describe an option when the market value of the underlying stock is equal to the strike price. In this situation, the option will remain unexercised, with the buyer losing the premium and the seller gaining the premium.
60
automatic exercise
The action taken by the OCC at expiration for all options that are in-the-money by at least $0.01 unless the customer gives other instructions.
61
bearish
The attitude of an investor who believes that stock prices will fall. Bearish strategies include selling stock short, selling calls, and buying put options.
62
breakeven
The market value for which an investor has no profit or loss on a position.
63
bullish
The attitude of an investor who believes that stock prices will rise. Bullish strategies include purchasing stock, buying calls, and selling put options.
64
call buyer
Has the right to buy shares at a set price until expiration of the contract. In return for this right, the call buyer pays a premium. Because investors want to exercise this right as prices increase, these investors are bullish on the stock.
65
call option
An option contract that gives the purchaser the right to buy the stock at a set price and the seller the obligation to sell the stock at a set price.
66
call premium
A dollar amount above par that an issuer may pay an investor to compensate the investor when the issuer redeems the bonds prior to maturity. Typically, the earlier the call date, the higher the premium.
67
call up
A trick to remember both the breakeven point and the in-the-money direction for call options. Call up reminds you to add the premium to the strike price to find breakeven and that calls are in-the-money whenever the market value is above the strike price. This is true regardless of whether the call is long or short.
68
call writer
Has the obligation to sell shares at a set price until expiration of the contract. In return for this obligation, call writers receive a premium. Because investors want the price to fall so the option expires, these investors are bearish.
69
class
Represents all calls or puts of an underlying issuer.
70
closing position
When an investor offsets his options position by repurchasing an option he originally sold or selling an option he originally purchased. When an investor closes his position, he is trading his option and effectively exiting the market. In this situation, the investor's profit or loss is the difference between what he paid when buying the option compared to what he received when selling the option.
71
closing purchase
When an investor that wrote an option exits that position by repurchasing that same contract.
72
closing sale
When an investor that owns an option exits that position by selling that same contract.
73
covered call
An option strategy in which an investor sells a call, while owning the underlying stock. It is considered a conservative strategy because if the call is exercised, the investor already owns the shares to make delivery, rather than having to buy the shares in the market at a much higher price. Investors benefit from the position through the income they earn from the premiums, which can also hedge some of their downside risk on the stock, while allowing them the potential to share in the long-term appreciation of their shares.
74
derivative
An investment whose value is tied to an underlying asset. Option contracts are an example.
75
European-style option
A type of options contract that can be exercised by the buyer on the expiration date. Many stock index options are European-style.
76
exercise
The action taken by owners of calls or puts who want to effect the right afforded to them. When a call buyer exercises, she purchases the stock at a set price, and when a put buyer exercises, he sells the stock at a set price.
77
expiration
The termination date of an options contract, when an investor can no longer exercise his contract or liquidate her position. Options contracts typically expire on the third Friday of the month, nine months after the issue date. However, LEAPS can have expirations of up to three years.
78
hedge
When an investor takes a position with an opposite outlook and attitude in order to protect an existing investment. For example, an investor who owns stock might purchase put options as a hedge to protect his downside risk, and an investor who sold stock short might purchase call options as a hedge to protect her upside risk.
79
in-the-money
A term used to describe the situation when an option is exercisable by the owner because it has intrinsic value. Calls are in-the-money when the market value of the underlying stock is above the strike price, and puts are in-the-money when the market value of stock is below the strike price.
80
index-based option
A type of option whose value is derived from the closing value of an entire stock index rather than a single stock.
81
LEAP option
A long-term option that can have an expiration of up to three years from the time of issuance. This is longer than the traditional nine-month expiration of most options.
82
maximum loss
The largest amount of losses an investor can incur on a position.
83
maximum gain
The largest amount of profits an investor can earn on a position.
84
options disclosure document
A document that details the risks involved in options trading and must be received by customers at or prior to their accounts being approved for options trading.
85
Options Clearing Corporation (OCC)
A clearinghouse that issues and guarantees all listed options contracts, meaning those that are exchange-traded. The benefit of this guarantee is that the OCC acts as a counterparty, standing between buyers and sellers for every contract and thus protecting against risk of default.
86
options agreement
A document that must be signed and returned by a customer within 15 days after account approval. It details the customer's agreement to position limits and verifies that the customer has read and received the options disclosure document.
87
opening sale
When an investor enters the options market by selling a call or a put.
88
opening purchase
When an investor enters the options market by purchasing a call or a put.
89
out-of-the-money
A term used to describe the situation when an option is not exercisable by the owner because it has no intrinsic value. Calls are out-of-the-money when the market value of the underlying stock is below the strike price, and puts are out-of-the-money when the market value of the stock is above the strike price.
90
premium
The cost of an options contract. This is paid by the buyer (who is purchasing the right to either buy or sell) and received by the seller (who is taking on the obligation to either buy or sell). It can be calculated as time value plus intrinsic value.
91
protective call
A call option purchased by an investor to reduce the risk of an established short stock position. The call option allows investors to lock in a fixed purchase price to cover their short positions regardless of how high the value of shares goes.
92
protective put
A put option purchased by an investor to reduce the risk of an established long stock position. The put option allows investors to lock in a fixed sale price for their stock, regardless of how low the price declines.
93
put buyer
Has the right to sell shares at a set price until expiration of the contract. In return for this right, put buyers pay a premium. Because investors want to exercise this right as prices fall, these investors are bearish on the stock.
94
put down
A trick to remember both the breakeven point and the in-the-money direction for put options. Put down reminds you to subtract the premium from the strike price to find breakeven and that puts are in-the-money whenever the market value is below the strike price. This is true regard-less of whether the put is long or short.
95
put option
An option contract that gives the purchaser the right to sell the stock at a set price and the seller the obligation to buy the stock at a set price.
96
put writer
Has the obligation to buy shares at a set price until expiration of the contract. In return for this obligation, put writers receive a premium. Because investors want the price to rise so the option expires, these investors are bullish.
97
series
The specific combination of a strike price and expiration within an option's class.
98
strike price
The price at which an investor can exercise an option or warrant and buy or sell the underlying shares. This is set at issuance and does not change.
99
time value
The portion of an option's premium that reflects the time remaining until expiration. Options with a longer time horizon have more time value, as there is a greater chance that the option will go deeper into-the-money before expiration. Therefore, as expiration approaches, time value will decay toward zero. It can be calculated as the total premium minus intrinsic value.
100
uncovered call
Also referred to as a naked call, an option position in which an investor sells a call option without owning the underlying stock. This strategy has unlimited risk because no matter how high the stock price goes, the investor must always sell the shares at the strike price if exercised.
101
uncovered put
A strategy where an investor sells a put option without depositing cash equal to the exercise value of the option. This is risky because if the investor is forced to buy the stock at the strike price, he may not be in a strong position to meet the purchase obligation.
102
What are the basics of **equity options**?
An option gives the owner the right, but not the obligation, to buy or sell 100 shares of the underlying security at some price, at some point in the future.
The price is called the strike, the right to buy is a "call," and the right to sell is a "put". Investor can both be long or short both calls and puts.
103
What are the reasons an investor would buy a call option?
* Because they are **bullish** on the stock and think the price will increase
* It is **less expensive** than buying the underlying shares (the investor is paying the premium rather than the cost of actually purchasing the stock)
* To **hedge a short stock position**
104
What is the meaning of an options contract that states:
**Buy 2 XYZ Oct 40 Calls @ 3**
* **Buy** means the investor is taking a long position in the contract and thus they will have the right to do something
* **2** reflects the number of contracts. Standard options contracts have 100 shares per contract. Thus in this example, 2 contracts each worth 100 shares for a total of 200 shares in this particular example
* **XYZ** is the security the investor is speculating on
* **Oct** is the expiration month. Most options contracts are issued with a 9 month expiration
* **40** is the strike price, which is where the investor has the right to exercise the contract
* **Call** is the class, which gives the investor the right to buy the stock at the strike price
* **@3** is the premium, which is the cost of the contract. In this case, for the right to buy XYZ at $40 per share, the investor is paying a cost of $3 per share x 100 shares per contract x 2 contracts ($600 in total in this example)
105
What does being short one IBM July 30 Call mean?
The investor has an obligation to sell IBM stock at $30 if the option is exercised by the buyer between now and the expiration date of July
106
**Under what circumstances** would an investor exercise a Jan 30 IBM call?
**If the shares are trading above 30** at the time the option expires, the investor would want to take advantage of their right to buy the shares at 30.
107
How much will investors pay in for a contract trading at a premium of $1.50 per share?
Option contracts typically represent 100 shares per contract. Therefore, the premium of $1.50 per share is multiplied by 100 to arrive at the cost of $150 for the contract.
108
Under what circumstances would you want to **exercise a Jan 30 IBM put**?
A put gives the owner the right to sell 100 shares of IBM stock at $30 per share. This investor would want to exercise their option if the shares were trading lower than 30 in order to sell the stock for more than it is actually worth.
109
When do options expire?
Options expire on **the third Friday of the month.**
110
What is the difference between a buyer and a seller of an option?
**Buyers of options**
* They are owners and open long positions (buying a call or buying a put)
* Buyers have a right to do something
* Pay a premium for that right
**Sellers of options**
* They are writers and open short positions (selling a call or selling a put)
* Sellers have an obligation to do something
* Receive a premium for that obligation
111
What are the four single options positions?
1. Buy a put - a right to sell stock
2. Sell a put - an obligation to buy stock
3. Buy a call - a right to buy stock
4. Sell a call - an obligation to sell stock
112
What are the attitudes of the four single options positions?
1. Buy Put - Bearish View
2. Sell Put - Bullish View
3. Buy Call - Bullish View
4. Sell Call - Bearish View
113
What does **in-the-money** refer to?
In-the-money means that the option is exercisable by the buyer of the option. Calls are in-the-money when the market value is above the strike price and puts are in-the-money when the market value of the stock is below the strike price.
114
At expiration, do buyers and sellers of options want the option to be "at", "in" or "out" of the money?
* Sellers want to collect the premium and have the option remain unexercised - this means they want **out-of-the-money** options at expiration
* Buyers want to have **in-the-money** options at expiration so they exercise there option
115
Knowing if an option is in or out of the money is important, but knowing **by how much** is even more important. What is this called?
The amount of money by which the option is **in-the-money** is called its **intrinsic value**. For example, if a call option has a strike price of $50 and the stock is trading at $60, the intrinsic value would be the in-the-money amount of $10. Remember, calls are in-the-money when the market value is above the strike price. If an option is out-of-the-money, then intrinsic value is zero (it cannot be negative).
116
What two components make up the **premium** of an option?
**Premium = Time value + Intrinsic Value**
1. **Intrinsic value** is the in-the-money amount of the option
2. **Time value** reflects the amount of time remaining until expiration
117
How does an investor calculate the **breakeven point** of a call option?
**Add the premium to the strike price.**
## Footnote
If you buy 1 Jan 30 IBM call at $2.25, the breakeven is $32.25. At that market value, the investor's gain on the option is offset by the loss on the premium. Remember, CALL UP
118
What is the breakeven for a customer who has sold 1 Feb IBM 30 calls at $2.45?
**Add the premium to the strike price.**
## Footnote
If you buy 1 Jan 30 IBM call at $2.45, the breakeven is $32.45. At that market value, the investor's loss on the option is offset by the gain on the premium. Remember, CALL UP
119
Which direction do owners of calls or puts want the stock price to be in comparison to breakeven?
The **owners of a call** will spend premium on the call so they want the stock to trade **above** the breakeven price. For puts the opposite is true. For **owners of puts they want the stock to trade below** the breakeven.
120
What are the basic **styles of option expiration?**
**American and European**
* **American** style can be exercised at any time prior to expiration
* **European** style can be exercised only at expiration
121
**What does it mean to close an options position?**
Closing an options position, means that the investor is liquidating position. If they initially bought an option, they will now sell it to close their position. If they initially sold an option, they will not buy it back to close their position.
122
What purpose does the **Options Clearing Corporation** serve?
The OCC issues and guarantees all options contracts. In doing so, they ensure the financials of the contract, which protects against default risk.
123
How does the OCC handle **option exercises?**
The OCC randomly assigns exercise notices to clearing firms, who then pass the notice along to a broker dealer, who then assigns to the customer in theory on a random basis.
124
What is the **maturity** of an options contract?
Most options are set up by the OCC to expire **nine months after issuance**. Some contracts, known as LEAPs options, have an expiration of longer than nine months.
125
What is the **maturity** of an options contract?
Most options are set up by the OCC to expire **nine months after issuance**. Some contracts, known as LEAPs options, have an expiration of longer than nine months.
126
How does the OCC handle **option exercises?**
The OCC randomly assigns exercise notices to clearing firms, who then pass the notice along to a broker dealer, who then assigns to the customer in theory on a random basis.
127
What purpose does the **Options Clearing Corporation** serve?
The OCC issues and guarantees all options contracts. In doing so, they ensure the financials of the contract, which protects against default risk.
