Options

Question 1

What is a put option?

Answer 1

The right to sell an asset at a predetermined price

Question 2

What is a call option?

Answer 2

The right to buy an asset at a predetermined price

Question 3

What does longing a call mean?

Answer 3

Buying the right not the obligation to buy the asset at the predetermined price

Question 4

What does longing a put option mean?

Answer 4

Buying the right not the obligation to sell the asset at the predetermined price

Question 5

What does shorting a call mean?

Answer 5

Selling the call option, obligating themselves to sell the asset at the predetermined price if the option is exercised

Question 6

What does shorting a put option mean?

Answer 6

Selling the put option, obligating themselves to buy the asset at the predetermined price if the option is exercised

Question 7

What are the two components of option value?

Answer 7

The time value and the intrinsic value

Question 8

What is the intrinsic value of a put option?

Answer 8

Max(0, X-S) where S is the current price in the market and X is the exercise price

Question 9

What is the intrinsic value of a call option?

Answer 9

Max(0, S-X) where S is the current price in the market and X is the exercise price

Question 10

What is the time value of an option?

Answer 10

The value that the option takes due to the likelihood of asset price change from its current price up until the option expiry

Question 11

Which variation of option is worth more, American or European?`

Answer 11

American > European

Question 12

When can a European option be exercised?

Answer 12

Only on the expiration date

Question 13

When can an American option be exercised?

Answer 13

Before and up until the expiration date

Question 14

What correlation does a call option have with a change in exercise price and why?

Answer 14

Negative, if the exercise price is higher there is a lower chance that the price will exceed that price and thus subtract from the intrinsic value. If the price is lower there is a higher chance that the price will exceed the exercise price and thus add to the intrinsic value.

Question 15

What correlation does a put option have with a change in exercise price and why?

Answer 15

Positive, if the exercise price is higher there is a higher change that the price will be below that price and thus add to the intrinsic value. If the price is lower there is a lower chance that the price will be below the exercise price and thus subtract from the intrinsic value.

Question 16

What correlation does a call option have with a change in spot price and why?

Answer 16

Positive, if the spot price is higher there is a higher likelihood that it will exceed the exercise price and thus add to the intrinsic value. If the spot price is lower there is a lower chance that the price will exceeed the exercise price and thus subtract from the intrinsic value.

Question 17

What correlation does a put option have with a change in spot price and why?

Answer 17

Negative, if the spot price is higher there is a lower chance that it will be below the exercise price and thus subtract to the intrinsic value. If the spot price is lower there is a higher chance that the price will be below the exercise price and thus add to the the intrinsic value.

Question 18

What correlation does a call option have with a change in interest rates and why?

Answer 18

Positive, if the interest rates are higher, the value of current money paid to buy the asset at the expiry date (or before the expiry) is lower and thus adds to the intrinsic value. If the interest rates are lower, the value of current money paid to buy an asset at the expiry (or before the expiry) is higher and thus subtracts from the intrinsic value.

Question 19

What correlation does a put option have with a change in interest rates and why?

Answer 19

Negative, if the interest rates are higher, the value of current money paid to sell the asset at the expiry date (or before the expiry) is lower and thus subtracts to the intrinsic value. If the interest rates are lower, the value of current money paid to sell an asset at the expiry (or before the expiry) is higher and thus adds to the intrinsic value.

Question 20

What correlation does a call option have with dividends and why?

Answer 20

Negative. If dividends are paid out, the spot price will experience a drop meaning that it is less likely to exceed the exercise price and thus subtract from the intrinsic value. If dividends are not paid out, the sport price will remain the same meaning that it has a higher likelihood that it will exceed the price and thus adds to the intrinsic value.

Question 21

What correlation does a put option have with dividends and why?

Answer 21

Positive. If dividends are paid out, the spot price will experience a drop meaning that it is more likely to be below the exercise price and thus adds to the intrinsic value. If dividends are not paid out, the sport price will remain the same meaning that it has a lower likelihood that it will be below the exercise price and thus subtracts from the intrinsic value.

Question 22

What correlation does a call option have with volitility and why?

Answer 22

Positive. The more volitile the price of an asset is, the more likely that it will experience a price increase and will thus add to the time value of an option.

Question 23

What correlation does a put option have with volitility and why?

Answer 23

Positive. The more volitile the price of an asset is, the more likely that it will experience a price decrease and will thus add to the time value of an option.

Question 24

What correlation does a call option have with time to expiry and why?

Answer 24

Positive. The more time until expiry, the more time for a price increase to occur and will thus add to the time value of an option

Question 25

What correlation does a put option have with time to expiry and why?

Answer 25

Positive. The more time until expiry, the more time for a price decrease to occur and will thus add to the time value of an option