Options Flashcards
To protect a long stock position from a falling market
- hedging
- buy a put ( stock declines, buy a put, and sell at strike price)
To protect a short stock position from a rising market
- hedging
- buy a call ( stock increases, exercise call and buy at strike price eliminating market risk)
To protect a long stock from a falling market
- long put/buy a put
long stock/ long put max gain
- unlimited
long stock/long put max loss
-premium paid
long stock/ long put breakeven-
sp + premium
To protect a short stock from a rising market
- long a call/ buy a call
short stock/ long call max gain
sp - premium
short stock/ long call max loss
premium
short stock/long call breakeven
sp + premium
a long stock/ long put is no different than ________
- buying a call
- unlimited upside potential ( from the stock)
- limited downside loss ( from the put)
Income strategies are used when
when the market is expected to be stable
To generate additional income in a stable market
- sell a call against a long stock
- sell a put against a short stock
long stock/ short call
- generate additional income in a stable market
- income strategy
- covered call
short stock/ short put
- generate additional income in a stable market
- income strategy
long stock/ short call max gain
premium received
long stock/ short call max loss
cost of stock price - premium
long stock/ short call breakeven
cost of stock price - premium
“out of the money” covered call is used when
- market is rising
short stock/ short put max gain
- premium
short stock/ short put max loss
- unlimited
short stock/ short put
- cost of stock + premium
Collar
- purchase of a put and the sale of a call
- he long put position protects the stock position against a downwards market move, while the short call provides income to offset the cost of the protective put.
Spread position
- purchase and sale of a call
or - purchase and sale of a put
at different strike prices or expirations or both, the strike and expiration being different
Long straddle
- purchase of a call, and purchase of a put on the same stock, with the same strike price and expiration
- if the market moves up, he gains on the call and the put expires
- if the market moves down, he gains on the put and the call expiries
- bets on the market being volatile
If an investor is placing a long straddle, what is he betting the market will do?
Be volatile, fluctuate
Short straddle
- sale of a call, and sale of a put, on the same stock with the same expiration and strike price
- if the market stays flat, both call and put expire and receives a double premium
- if the market rises the call goes in the money and will be excercises as the put goes out of the money
short straddle and risk
- double the risk, not very popular
Long straddle max potential gain
- unlimited
long straddle max potential loss
- combined premium paid/ debit
short straddle max potential gain
- combined premium/ credit
short straddle max potential loss
- unlimited
Long combination
- purchase of a call, and purchase of a put, on the same stock with different strike prices or expirations
short combination
- sale of a call, and sale of a put, on the same stock with different strike prices of expirations
long strangle
- purchase of an out of money call and purchase of an out of money put
- -strike price is higher than the current market and strike price is lower than the current market
- market must move sharply to be profitable
The customer believes that the market will move sharply but unsure of the direction, you recommend ______
- buy a straddle to profit
long straddle upside breakeven
= call strike price + debit ( premiums paid)
long straddle downside breakeven
= call strike price - debit ( premiums paid)
Customer bets the market is going to stay the same and has a high level of risk, you recommend a _____
short straddle
short straddle upside breakeven
= call strike price + credit
short straddle downside breakeven
= call strike price + credit
short straddle max loss
unlimited
Which of the following create a straddle? I Short 1 ABC Jan 50 Call Short 1 ABC Jan 50 Put II Short 1 ABC Apr 50 Call Short 1 ABC Oct 50 Put III Short 1 ABC Jan 50 Call Long 1 ABC Jan 50 Put IV Long 1 ABC Jan 50 Call Long 1 ABC Jan 60 Put
A I only
B I and III
C II and IV
D III and IV
The best answer is A. A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.
On the same day when the market price of ABC is $48, a customer:
Buys 1 ABC Jan 50 Call @ $3
Buys 1 ABC Jan 50 Put @ $5
The market rises to $60 and the call is exercised and the resulting stock position is sold in the market. The put expires worthless. The gain or loss is:
A $200 gain
B $700 gain
C $800 loss
D $1,000 loss
The best answer is A.
If the stock moves to $60, the call goes “in the money” and will be exercised and the put expires “out the money.” When the call is exercised, the customer buys the stock at the strike price of $50, and sells it at the current market price of $60, for a 10 point gain. However, since 8 points was paid in combined premiums, the net result is a gain of 2 points or $200.
On the same day in a cash account, a customer purchases 1 MNO Mar 45 Call @ $3 and 1 MNO Mar 45 Put @ $1, when the market price of MNO is $44.38. Subsequently, MNO goes to $38 and the customer lets the call expire and closes the put at intrinsic value. The customer has:
A $300 gain
B $700 gain
C $300 loss
D $400 loss
A
This is a long straddle:
Buy 1 MNO Mar 45 Call @ $3
Buy 1 MNO Mar 45 Put @ $1
$4 Debit
If the market drops below $45, the call will expire “out the money” and the put goes “in the money.” Here the put is “in the money” (or has intrinsic value of) 7 points. This results in a 7 point profit on the put, if it is “closed” (sold) at intrinsic value. But, since 4 points were paid in premiums, the customer has a net gain of 3 points per share, or $300.
A customer buys 1 ABC Jan 30 Call @ $3 and buys 1 ABC Jan 30 Put @ $4 when the market price of ABC = $31. The maximum potential loss is:
A $600
B $700
C $1,500
D $3,000
The best answer is B. If the market stays at $30, both contracts expire “at the money.” The customer loses the $700 paid in premiums. This is the maximum potential loss.
A customer buys 1 ABC Jan 50 Call @ $4 and buys 1 ABC Jan 50 Put @ $6 when the market price of ABC is $49. At which market prices is the position profitable? I $39 II $40 III $60 IV $61 A I and IV only B II and III only C II and IV only D I, II, III, IV
The best answer is A.
A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $10 in premiums was paid, the market must move down by more than 10 points to profit on the put; or must move up by more than 10 points to profit on the call. Thus, the position is profitable at either $39 or $61. Note that $40 and $60 are the breakeven points. To summarize, the breakeven formulas for a long straddle are:
If the market price of the underlying security remains the same as the strike price of the option contract, which of the following will have a profit?
I The buyer of an “at the money” straddle
II The seller of an “at the money” straddle
III The seller of an “at the money” call
A I only
B II only
C III only
D II and III
The best answer is D. If the market price remains the same as the strike price, then there is no reason for the holder of an option contract to exercise. The contracts will expire and the holder will lose the premium, while the writer will gain the premium. Sellers of contracts and straddles (the sale of a call and a put on the same stock with the same strike price and expiration) will profit. Holders of contracts and straddles will lose the premiums paid.
If ABC is at a market price of $50, which of the following positions will be profitable?
A Long 1 ABC Jan 60 Call @ $5; Long 1 ABC Jan 60 Put @ $5
B Short 1 ABC Jan 60 Call @ $5; Short 1 ABC Jan 60 Put @ $5
C Long 1 ABC Jan 50 Call @ $5; Long 1 ABC Jan 50 Put @ $5
D Short 1 ABC Jan 50 Call @ $5; Short 1 ABC Jan 50 Put @ $5
The best answer is D.
Choice A is a long 60 straddle. If the market goes to $50, the put is 10 points “in the money,” while the call is 10 points “out the money” and will expire. The 10 point profit on the put exactly offsets the total 10 point premium paid - this is breakeven.
Choice B is a short 60 straddle. If the market goes to $50, the put is 10 points “in the money,” while the call is 10 points “out the money” and will expire. The 10 point loss on the put exactly offsets the total 10 point premium received - this is breakeven.
Choice C is a long 50 straddle. If the market stays at $50, both the call and the put expire “at the money” and the holder loses the premiums paid.
Choice D is a short 50 straddle. If the market stays at $50, both the call and the put expire “at the money” and the writer gains the premiums received.
On the same day, a customer:
Sells 1 ABC Jan 45 Call @ $4
Sells 1 ABC Jan 45 Put @ $3
At that time, the market price of ABC is $44. If the market rises to $58 and the call is exercised (the put expires out the money), the gain or loss is:
A $600 loss
B $700 loss
C $700 gain
D $1,300 gain
The best answer is A.
If the market rises to $58, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $45 on the short call. Since the price in the market is $58, the customer loses 13 points. After deducting the 7 points of premiums collected, the net loss is 6 points or $600.
A customer sells 1 ABC Jan 30 Straddle for a total premium of $500. At expiration, ABC closes at $21 and the customer is exercised. As a result, the customer will have a:
A $100 gain
B $400 gain
C $400 loss
D $900 gain
The best answer is C. When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:
Sells 1 ABC Jan 30 Call
Sells 1 ABC Jan 30 Put
$500 Credit
If the market stays exactly at $30, both positions expire and the customer would gain the $500 credit. In this case, the market declines to $21. The call expires “out the money,” while the put is 9 points “in the money” and is exercised at a loss of 9 points = $900 loss. Since $500 was received in premiums, the net loss is $400.
A customer sells 1 ABC Jan 70 Call @ $4 and sells 1 ABC Jan 70 Put @ $1 on the same day when the market price of ABC stock is $72. Assume that the market price falls to $66 and the call premium falls to $.50, while the put premium rises to $5.50. The customer closes the positions. The gain or loss is:
A $100 gain
B $100 loss
C $500 gain
D $500 loss
The customer established two positions with a credit of $5 x 1 contract = $500 credit. When the market is at $66, the customer closes the call at $.50 and closes the put at $5.50. Thus, the positions are closed at:
Buy 1 ABC Jan 70 Call @ $ .50
Buy 1 ABC Jan 70 Put @ $5.50
$6.00 debit = $600 debit
The customer closed for a debit of $600. Since the initial credit was $500, the customer has a $100 loss.
A customer sells 1 ABC Jan 50 Call @ $3 and sells 1 ABC Jan 50 Put @ $6 when the market price of ABC is $48. At which market prices is the position profitable? I $44 II $42 III $40 IV $38 A I and II only B II and III only C I and IV only D III and IV only
The best answer is A. A short straddle is the sale of a call and the sale of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. If the market stays at the strike price, then both contracts expire “at the money,” and the premiums collected represent the maximum gain. Since $9 in premiums was collected, the market must move down by more than 9 points to lose on the put; or must move up by more than 9 points to lose on the call. Thus, the position is unprofitable if the market moves below $50 - $9 = $41 per share; or moves above $50 +$9 = $59 per share. The position would be profitable between $42 and $58 per share. To summarize, the breakeven formulas for a short straddle are:
A customer sells 1 ABC Jan 50 Call @ $4 and sells 1 ABC Jan 50 Put @ $6 when the market price of ABC is $49. At which market prices is the position profitable? I $40 II $41 III $59 IV $60 A I and III B I and IV C II and III D II and IV
The best answer is D.
If the market price remains the same at expiration, “at the money” options contracts will expire. This means that the writer of the contract will earn the premium and the holder will lose the premium.
Since a long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration, the buyer of an “at the money” straddle will lose the premiums paid if the stock price remains unchanged because both positions will expire. On the other hand, the writer of that straddle, the sale of a call and a put on the same stock, will earn the premiums.
Spread
- purchase of a call and sale of a call at different strike prices or expiration
- limits gains and losses
long call spread/ debit spread
- purchase of a lower strike price call @ a higher premium
- sale of a higher strike price call @ a lower premium
- long call spread the long call premium is higher
buy the lower strike price and sell the higher strike price ALWAYS
short call spread/ credit spread
- sale of a lower strike price call @ a higher premium
- purchase of a higher strike price call @ a lower premium
long put spread
- purchase of a higher strike price put @ a higher premium
- sale of a lower strike price put @ a lower premium
short put spread
sale of a higher strike price put at a higher premium
purchase of a lower strike price put at a lower premium
The customer believes that XXX stock will rise in the near future but will not be very volatile and doesn’t expect the stock to rise more than 10 points, what do you recommend
Long call spread
Long Call Spread: bull or bear
bullish
long call spread max loss
Debit
long call spread max gain
the difference of strike prices - debit
long call spread breakeven
long strike price + debit
the customer believes that XXX stock will fall in the near future and will not be volatile and doesn’t expect it to fall below ten points. He wants to limit risk. What would you recommend
short call spread
Short call spread: bull or bear
bear
short call spread max gain
credit
short call spread max loss
the difference of strike prices- credit
short stock spread breakeven
short call strike price + credit