Options Flashcards
Options Overview: The Owner
The Owner
- Buyer
^ Long the option
^ Pays the premium
^ Acquires a right/control
Options Overview: The Writer
The Writer
- Seller
^ Short the option
^ Receives the premium
^ Assumes an obligation
Buy 1 ABC June 50 Call at 5
Pay $500 for the right to buy 100 shares of ABC at $50/Share up until the third Friday of June.
When are Calls in the money and out of the money?
Calls:
^ In the money if the market price is above strike
price
^ Out of the money if the stock is below the strike
price
When are Puts in the money and out of the money?
Puts:
^ In the money if the market price is below the strike
price
^ Out of the money if the market price is above the
strike price
Phone Analogy for when an option is in the money
You call someone and they can put down the receiver.
Call up
Put down
If the call is above the strike price, in the money
If the put is below the strike price, in the money
Intrinsic Value
The concept of INtrinsic value is tied to options that are IN-the-money
Intrinsic value is the amount by which an option is in-the-money
An option’s premium
Premium = Intrinsic Value + Time Value
Time Value is based on
Time left until expiration
Market volatility
The OCC and Options Trading
The options clearing corporation:
- Eliminates counter party risk by acting as the third
party in all option transactions
^ Acts as the buyer for all sellers and the seller for
all buyers - Deals directly with B/Ds, not customers
Four Key Concepts for Basic Options
- Strategy
a. For option BUYERS, remember the phrase
“CALL UP and PUT DOWN”
i. Buyers of Calls are BULLISH
ii. Buyers of Puts are BEARISH
b. Sellers are the opposite (Sellers of Calls are
BEARISH and Sellers of Puts are BULLISH) - Breakeven
a. To find the stock price (value) at which an
investor will breakeven, remember the
phrase “CALL UP and PUT DOWN”
i. For Calls, strike price + premium (CALL
UP)
ii. For Puts, strike price - premium (PUT
DOWN) - Maximum Gain
a. For SELLERS of options, the PREMIUM
received represents the MAXIMUM GAIN
b. For BUYERS of Calls, the maximum gain is
UNLIMITED (since a stock’s rise is
unlimited)
c. For BUYERS of PUTS, the maximum gain is
realized if the stock falls to zero (i.e., strike
price - premium * 100 shares) - Maximum Loss
a. For BUYERs of options, the PREMIUM paid
represents the MAXIMUM LOSS
b. For SELLERS of Calls, the maximum loss is
UNLIMITED (since a stock’s rise is
unlimited)
c. For SELLERS of Puts, the maximum loss is
realized if the stock falls to zero (i.e., strike
price - premium * 100 shares)
Random Questions:
- Market price above strike price
- Premium - intrinsic value
- Increase in the number of contracts, but the
shares in the contract stay the same
- Required document when opening an options
account
- Strike price + premium
- Strike price - premium
- Market price above strike price
○ CALLS in-the-money and PUTS out-of-
money
- Premium - intrinsic value
○ Time value
- Increase in the number of contracts, but the
shares in the contract stay the same
○ Even split adjustment
- Required document when opening an options
account
○ Options disclosure document
- Strike price + premium
○ Breakeven for long and short calls
- Strike price - premium
○ Breakeven for long and short putsStraddles and Combinations
Created by either:
^ Buying both a call and a put on the same underlying
security. Or,
^ Selling both a call and a put on the same underlying
security
Strategy:
^ Long straddle or combination: VOLATILITY
^ Short straddle or combination: STABILITY
Straddle:
^ Same expiration months and strike prices
Combination:
^ Different expiration months and/or strike prices
If an investor has one option component and adds another to create a multiple option position, he is considered to have legged into the position.
Uncertain of the direction in which ABC stock is going to move, an investor:
Buys 1 ABC Jun 40 Call at 3
Buys 1 ABC Jun 40 Put at 2
Breakeven points:
Strategy:
Max gain:
Max loss:
The total (combined) premium is 5
Breakeven Points:
^ 40 + 5 = 45 and,
^ 40 - 5 = 35
Strategy: ^ Volatility Maximum Gain: ^ Unlimited Maximum Gain: ^ $500 Premium
Believing that ABC’s stock price will remain flat, an investor:
Sells 1 ABC Jun 40 Call at 3
Sells 1 ABC Jun 40 Put at 2
Breakeven points:
Strategy:
Max gain:
Max loss:
The total (combined) premium is 5
Breakeven Points:
^ 40 + 5 = 45 and,
^ 40 - 5 = 35
Strategy: ^ Stability Maximum Gain: ^ $500 Premium Maximum Gain: ^ Unlimited
Spreads
Positions which allow an investor to limit losses in exchange for limiting gains
- Created with the sale and purchase of two options of
the same class, but different series^ Class: options of the same type on the same
underlying security
^ Series: options of the same class, same expiration,
and same strike price - Spreads may be either bullish or bearish and either
debit or credit
Different types of Spreads
The difference in the series is what identifies them
- Price/Dollar/Vertical Spread ^ Buy 1 ABC Jun 40 Call ^ Sell 1 ABC Jun 50 Call - Time/Calendar/Horizontal Spread ^ Buy 1 XYZ Dec 40 Call ^ Sell 1 XYZ Sep 40 Call - Diagonal Spread ^ Buy 1 DEF Sep 40 Put ^ Sell 1 DEF Mar 30 Put
An investor who is moderately bullish on XYZ stock, but wants to minimize the cost of establishing the position, does the following:
Buys 1 XYZ Feb 80 Call at 3
Sells 1 XYZ Feb 90 Call at 1
Spread Rules: Net Premium: Buyer or Seller: Debit or Credit: Widen or Narrow: Breakeven: Bull or Bear: Max Gain: Max Loss:
Spread Rules: The breakeven must be between the
strikes
The max gain PLUS the max loss will equal
the difference in the strike prices
Net Premium: $200
Buyer or Seller: Buyer
Debit or Credit: Debit (we are paying out the premium)
Widen or Narrow: Widen
^ Just memorize: Debit = Widen, Credit = Narrow
(5 Letters) (6 Letters)
Breakeven: 80 + 2 = 82
Bull or Bear: Bullish
Max Gain: $800
Max Loss: $200 Net Premium
An investor who is moderately bullish on XYZ stock, but wants to minimize the risk of a short position, does the following:
Sells 1 ELG Nov 95 Put at 8
Buys 1 ELG Nov 80 Put at 1
Spread Rules: Net Premium: Buyer or Seller: Debit or Credit: Widen or Narrow: Breakeven: Bull or Bear: Max Gain: Max Loss:
Spread Rules: The breakeven must be between the
strikes
The max gain PLUS the max loss will equal
the difference in the strike prices
Net Premium: $700
Buyer or Seller: Seller
Debit or Credit: Credit
Widen or Narrow: Narrow
Breakeven: 95 - 7 = 88
Bull or Bear: Bull
Max Gain: $700
Max Loss: $800Spreads - Bull/Bear, Debit/Credit, Widen/Narrow?
Buy an XYZ Nov 90 Call
Sell an XYZ Nov 80 Call
Write an ABC Mar 35 Put
Buy an ABC Mar 40 Put
Short a JMK Oct 75 Call
Long a JMK Dec 75 Call
Buy an XYZ Nov 90 Call Sell an XYZ Nov 80 Call (Bearish, Credit, Narrow) - For CALL spreads, the dominant leg is always determined by the LOWER strike
Write an ABC Mar 35 Put Buy an ABC Mar 40 Put (Bearish, Debit, Widen) - For PUT spreads, the dominant leg is always determined by the HIGHER strike
Short a JMK Oct 75 Call
Long a JMK Dec 75 Call
(Debit, Widen)
Butterfly Spreads
What insect has a short body, but two long wings?
A combination of two spreads - one is a debit and one is a credit
^ Can be created with either calls or puts
Main thing to know about Butterfly Spreads
The maximum gain is at the middle strike price
Different purposes for utilizing options
Speculation
- Options can be purchased or sold to generate a
profit
- In this case, the investor has no existing position
in the underlying security
○ Long Calls and Short Puts are bullish
○ Long Puts and Short Calls are bearish
Hedging
- To hedge (protect) an existing stock position, an
investor could BUY an option
○ Long Puts may be used to protect the
downside risk of a long stock position
○ Long Calls may be used to protect the
upside risk of a short stock position
Generate Income
- To generate income on an existing stock
position, an investor could SELL an option
○ Short Calls may generate income on long
stock positions
o Short Puts may generate income on short
stock positions
If you’re Long stock position and you want to protect it:
If you’re Long stock position and you want to generate income:
If you’re Short stock position and you want to protect it:
If you’re Short stock and you want to generate income:
If you’re Long stock position and you want to protect it:
- Buy a Put
If you’re Long stock position and you want to generate income:
- Sell the Call
If you’re Short stock position and you want to protect it:
- Buy a Call
If you’re Short stock and you want to generate income:
- Sell the Put
Covered and Uncovered Positions
- Uncovered options are done in margin accounts, not cash accounts*
- Covered options can be done in margin or cash accounts*
Covered call is when you own the underlying stock
Uncovered call is when you do not own the underlying stock
Stock and Option Positions
- To protect (or hedge) stock in a volatile market:
- To generate income in a stable market:
- To protect (or hedge) stock in a volatile market:
○ Long Stock + Long Put
^ If the stock decreases, the value
gained on the put can offset the loss
on the stock
○ Short Stock + Long Call
^ If the stock increases, the value gained
on the call can offset the loss on the
stock- To generate income in a stable market:
○ Long Stock + Short Call (Covered Call) OR,
○ Short Stock + Short Put (Covered Put)
^ For both positions, if the stock remains
stable, the options will expire and the
premiums will be retained
^ However, for the Covered Put, the
upside risk is unlimited
- To generate income in a stable market:
If the test asks, “You’re short stock - how do you protect it”?
The better option is buying the Call.
- You can Short a covered put, but if the stock rises - you’ll only get the premium from selling the put. Because you’re short stock, you have unlimited upside risk if the stock rises.
Ratio Call Writing
A position that consists of a long stock position, but more calls written than the number of shares owned.
If you write more calls than shares that you own, it will have unlimited risk
Index Options
Provide the opportunity to speculate on, or hedge against, the movement of the market, rather than the movement of a specific stock
Broad-based Index:
^ Reflects performance of the entire market
Narrow-based Index:
^ Reflects performance of a particular sector
Volatility Index (VIX) Options
The VIX is a barometer of investor sentiment and expected market volatility
^ Based on the S&P 500 index options
How would you use the VIX
When does volatility tend to increase?
- When the market drops abruptly
If an investor believes the S&P 500 Index will fall in value, an investor may:
- Buy VIX Calls
World Currency Options
Proved the opportunity to speculate on, or hedge against, the movement of exchange rates on foreign currencies compared to the U.S. dollar
There’s no options on the U.S dollar - it just compares them to the U.S. dollar
Buying a foreign currency put
You are a U.S. exporter and will be paid in a foreign currency. You will have to convert the foreign currency to the U.S. dollar when you receive the payment. Your fear is that the value of the foreign currency will drop, so you buy a put to hedge against that risk.
Buying a foreign currency call
You are a U.S. importer and will pay the foreign country with their currency. Your fear is that the foreign currency will go up and cost you more when you have to obtain the currency upon delivery of the imports. So, you buy a call to hedge the risk against your fear.
Interbank Market
This is where currency spot prices are established.
The Interbank Market:
^ Has unlimited trading hours (spot trades)
^ Is unregulated and decentralized
Currency options trade on philly market
World Currency Option Multiplier
$100
Yield-Based Option Strategies
Preferred stock and bond prices and yields are inversely related:
^ When anticipating a fall in bond prices, an investor
expects a rise in bond yields
^ When anticipating a rise in bond prices, an investor
expects a fall in bond yields
If an investor believes: Yields will decrease, they should
If an investor believes: Yields will increase, they should
If an investor believes: Yields will decrease, they should
^ Buy yield-based puts or
^ Sell yield-based puts
If an investor believes: Yields will increase, they should
^ Buy yield-based calls or
^ Sell yield-based puts
Option Taxation:
- Expire Worthless
- Liquidated, Offset, Closed-Out
- Exercised
Option Taxation:
- Expire Worthless
^ Capital gain for the seller, capital loss for the buyer
^ Generally S/T gain/loss
^ Unless, if a LEAPS is purchased and held for more
than one year - Liquidated, Offset, Closed-Out
^ Usually S/T gain/loss (compare premiums,
difference is gain or loss)
^ Unless if you purchase and held a LEAPS for more
than a year - Exercised
^ The option premium will not generate a gain or loss
^ To calculate the cost basis or sales proceeds:- Of an exercised call, the premium is added to the
strike price (i.e., CALL UP) - Of an exercised put, the premium is subtracted
from the strike price (i.e., PUT DOWN)
- Of an exercised call, the premium is added to the
An investor is long one ABC Jun 90 Call at 4. If the option is later exercised, the investor will have a basis of _________
$9400
$9000 for the stock
$400 for the premium
An investor owns 100 shares of XYZ at $42 per share and sells an XYZ Dec 40 Call for 3. If the call is exercised, what are the investor’s sales proceeds for tax purposes?
$4,300
The cost of the stock when the investor purchased it is irrelevant. The question is asking what the investor’s sales proceeds were.
An investor is long a DEF Feb 45 Put at 3. If the option is alter exercised when DEF is at 40, the investor will have proceeds of _______
$4,200
Remember, call up - put down
It’s a put, so subtract the premium from the proceeds
Puts and Holding Periods: Stock Holding Periods
If a stock’s long-term holding period is not yet established:
^ The purchase of a put terminates the holding period
for the stock
^ The holding period begins anew only after the put
expires or is closed out
If a stock’s long-term holding period is already established, a put purchase does not change it (it remains long-term)
Puts and Holding Periods: Married Put
A put purchased on the same day that stock is purchased
^ The holding period for the stock starts on the
purchase date
^ The premium paid becomes part of the stock’s
basis, even after expiration
A straddle involves
Buying or selling both a call and put on the same underlying security, with the same strike price, and the same expiration date
The breakeven on a straddle is found by ______________ and _______________ from the strike price
The breakeven on a straddle is found by adding the total premiums and subtracting the total premiums from the strike price
Vertical spreads have _____________, but __________
Vertical spreads have different strike prices, but the same expiration dates - and vice versa
For vertical spreads, the difference in the strike prices equals the ________________
For vertical spreads, the difference in the strike prices equals the maximum gain + maximum loss
A debit put spread is _________ and the investor wants the spread to __________
A debit put spread is bearish and the investor wants the spread to widen
Long calls are used to hedge ___________ and short calls generate income on ___________
Long calls are used to hedge short positions and short calls generate income on long positions
A VIX call will likely become valuable after the market _______
A VIX call will likely become valuable after the market falls
If an investor believes bond prices may be falling, she may want to purchase __________
If an investor believes bond prices may be falling, she may want to purchase yield-based calls
The holding period on stock and a put on the stock will run concurrently if the two are
The holding period on stock and a put on the stock will run concurrently if the two are married (bought on the same day)
