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
long put spread: bull or bear
bear
long put spread max loss
debit
long put spread max gain
difference of strike prices - debit
long put spread breakeven
- long strike price - debit
short put: bull or bear
bull
short put spread max gain
credit
short put spread max loss
difference of strike prices - credit
breakeven
short strike price - credit
A diagonal spread
is essentially a combination of a vertical and an horizontal spread.
Purchase and sale of a call; or
Purchase and sale of a put;
with different strike prices and different expirations.
The debit spreads are:
Bull Call Spread:
Buy Lower Strike Call
Sell Higher Strike Call
Bear Put Spread:
Buy Higher Strike Put
Sell Lower Strike Put
Calendar
Debit Calendar Spread:
Buy Far Expiration
Sell Near ExpirationThe credit spreads are
Bear Call Spread:
Sell Lower Strike Call
Buy Higher Strike Call
Bull Put Spread:
Sell Higher Strike Put
Buy Lower Strike Put
Credit Calendar Spread:
Sell Far Expiration
Buy Near ExpirationFor a debit spread to be profitable
- it must be closed at a larger credit
- spread must widen
credit spread is profitable if
- must be closed at a lower debit
- spread must narrow
Debit price spread
- if both positions exercised, the customer gains the difference in strike prices
credit price spread
- if both positions expire, receives credit premium to be profitable
A ratio call write
is an income strategy suitable for a “flat” market.
If the market stays the same, 2:1 ratio
then both calls expire “at the money” and double premium income has been collected.
If the market drops, 2:1 ratio
then the calls expire “out the money” and customer begins to lose on the stock position (offset by the double collected premiums).
If the market rises 2:1 ratio
he calls go “in the money” and are exercised. If the cost of the stock and the strike price on the calls are the same, there is no gain or loss on the “covered” call(s). However, the exercise of the naked call(s) obligates the writer to deliver stock at the strike price that he does not own.
A customer buys 100 shares of ABC stock at $50 and sells 1 ABC Jan 50 Call @ $4 and sells 1 ABC Jan 50 Put @ $3. The customer’s maximum potential loss is:
A $700
B $4,300
C $9,300
D Unlimited
he best answer is C. This customer has a long stock position with a short straddle. The customer believes that the market will remain flat for the life of the options; and the customer will retain the total premium of $700 if this occurs. If the market falls, the short put is exercised and the short call expires. The exercise of the short put obligates the customer to buy 100 shares of ABC stock at $50, in addition to the 100 shares already owned at $50. In a falling market, the customer will sustain a loss on the 200 shares of ABC - with the maximum loss occurring if the stock falls to “0.” In this case, the customer loses $50 paid per share x 200 shares = $10,000 - $700 collected premiums = $9,300. On the other hand, if the market rises above $50, the short call is exercised and the short put expires. In this case, the customer must deliver the 100 shares owned for $50 received per share. Since the customer paid $50 per share, the only gain is the combined $700 premium received.
Which of the following positions is a Ratio Spread?
A Buy 1 ABC Jan 50 Call; Buy 1 ABC Jan 50 Put
B Buy 100 shares of ABC stock; Sell 2 ABC Jan 50 Calls
C Buy 1 ABC Jan 50 Call; Sell 2 ABC Jan 60 Calls
D Buy 1 ABC Jan 50 Call; Sell 1 ABC Jan 60 Call
The best answer is C. Choice A is a straddle. Choice B is a ratio call write strategy where the customer is selling more call contracts than his long position. Choice D is a simple vertical or price spread. Choice C is a ratio spread because there is more than 1 short call contract (in this case there are 2) written against the 1 long call contract.
On the same day in a margin account, a customer buys 5 ABC January 40 Calls @ $6 and sells 10 ABC January 50 Calls @ $1 when the market price of ABC is at $43. The customer has created a:
A short combination
B long combination
C ratio spread
D back spread
he best answer is C.
This is a very difficult question. The customer is taking the following positions:
Buy 5 ABC Jan 40 Calls @ $6
Sell 5 ABC Jan 50 Calls @ $1
$5 Debit
Sell 5 ABC Jan 50 Calls @ $1 Credit
The customer is creating 5 “long call spreads” and has 5 naked calls. In effect, he is writing 2 times the number of short calls needed to create the spread. Therefore he is “writing at a 2:1 ratio.” This is termed a ratio spread. Long call spreads are used when a customer is moderately bullish, and wishes to reduce the cost of the long position by selling an equal number of “out the money” calls. This limits upside gain potential, but also reduces the cost of the positions. By writing twice the number of calls, the customer further reduces the cost of the positions, but also assumes unlimited upside risk on the 5 naked calls that are left.
Strategies with Unlimited Gain…
Long Call
Long Stock
Long Stock / Long Put
Long Straddle
OCC
- issues the options
- guarantees the contract
- acts as a clearinghouse
Option contract specifications
- standard size of 100
- standardized strike price of 2 1/2 points (5$)
- standarized expiration
The expiration date of Options
- trades until the expiration date
- third Friday of the month at 11:59 EST
Spot/ Next month
- for each issue, an option can always trade for this month, and for next.
Max contract life of the option
8 months
Technical Max contract life of the option
9 months
Trading cut off
third Friday of the month at 400 pm est
Excercise cut off
third Friday of the month at 530 pm est
Before opening an options account, this form is required to be received
Option Disclosure Document
Option settlement
next business day regular way
If a call writer is assigned an exercise notice
must deliver the stock 2 business days from exercise date.
If a put writer is assigned an exercise notice
must pay for the stock 2 business days from exercise date.
If an option is exercised
the holder tenders an exercise notice to the O.C.C.
The O.C.C. selects a writer to be assigned the exercise notice on a random basis.
Acting In Concert
Any accounts that are under “common control” are aggregated to determine if there is a position limit violation.
Position Limit Aggregation Controls
- all owners in a joint account
- each general partner in a partnership account
- accounts with common directors
- individuals with authority to execute transactions in an account
Excercise Limit
- limits on the number of contracts that can be excercised in 5 business days
Adjustments to Contracts- Stock Split/ Dividend
- number on contracts up/ stock reduced
Covered Call Writing Positions Short Call
- long the underlying stock
- long a call at the same strike price or lower that expires in the same month or after the short call
- long an escrow receipt
- bank guarantee letter
Covered Put Writing Positions Short Put
- short the underlying stock position
- long a put at the same stock price or higher that expires in the same month or month after short put
- bank guarantee letter
LEAPS
- trade alongside regular stock options
- have much higher time premiums since expiration is longer
Cycle 1- LEAPS
LEAPs issued after the September expiration for the January that is 28 months later;
Cycle 2- LEAPS
LEAPs issued after the October expiration for the January that is 27 months later; and
Cycle 3- LEAPS
LEAPs issued after the November expiration for January that is 26 months later.
longest expiration cycle of a LEAP
28 months
in any given January the longest expiration Equity LEAP is
24 months
Listed options are traded on
exchanges, not OTC
If the stock stops trading in its principal market
then any options on that stock stop trading on the exchange that trades the option
The Floor Broker on the CBOE
- handles executable orders as agents for retail member firms
- earns a fee
- does not take inventory positions
Orders of floor brokers
- public orders and orders for member firm trading accounts
- obtain best available price
If a Floor Broker has orders from two different customers TO buy and sell the same contract
Floor broker must first attempt an execution on the trading floor
- if he cannot do this, then he must publicly announce he is crossing
CBOE Options Trading: Market Maker
- maintains a bid and quote for assigned options contract
- trades for their own inventory for the security they are registered for, cannot be FLOOR BROKER in this security, however, can be a floor broker in a security they are not registered with
- earns the spread between the bid and ask quote
CBOE Options Trading: Order…
- maintains book of public orders that are away from the current market, executes them when they move in desired direction
- can only accept limit orders, cannot accept not held or stop
- earns a commission
DPM
- ACTS AS A MARKET MAKER, FLOOR BROKER, AND ORDER BOOK SPECIALIST
- maintains a bid and ask quote in each assigned options, handle the book of public orders
Order priority of options
- public orders have priority of member firms or market makers
- highest bid and lowest ask displayed by OBO will have highest priority
Spread Priority Rule
- spread limit orders have priority over singe contract limit orders
- spreads, straddkes, strangles
- written on 1 ticket
Filling a spread options order
- purchases of option contracts are made at the market maker’s ask quote, sales are made at the market maker’s bid quote
Accommodation Liquidations/ Cabinet trades
- a means for customers to close out worthless contracts
- closing trade record at .01 per share, helpful for tax purposes
Order Support System
- routes orders directly to the market maker and OBO and sends trade reports back to the reporting firm
Index options allow
for speculating on the direction of the market as a “whole.”
Purchaser of index call will profit if
the value of the index goes up,
purhcaser of and index put will profit
the value of the index goes down
Broad Based
OEX and SPX
Narrow Based
one based on a stock index that is industry-specific or country-specific.
OEX
- Trades on CBOE
- Most actively traded
- consists of 100 capitalization stocks in the S&P 500
- American Style (excerisable any time)
SPX
- European style
- only exercisable at the expiration date
XMI
- “Major Market Index” traded on the AMEX
- mimic the Dow Jones, MOVES PARALLEL
f the portfolio has a beta of +1,
then its volatility is the same as the market.
If the portfolio has a beta of +1.5
then it is 1.5 times as volatile as the market.
If the portfolio has a beta of +2,
then it is 2 times as volatile as the market.
beta adjust” a hedge
the regular number of contracts x beta = the number of contracts needed to hedge
ratio of put contracts
gives an indication of “market sentiment” - this is the put/call ratio.
Ratio of puts traded to call contracts is high
high= over sold
prices are close to the bottom the market will move upwards
ratio of puts traded to calls traded is very low
that the market is “overbought” - and that prices are close to a top; therefore, the next market move will be downwards.
Expiration of OEX
- 4 months
LEAP max life for OEX
36 months
VIX
Benchmark index gauges the investor sentiment
- calculates expected SPX volatility in upcoming month
- euoropean style
VIX value of 0
implies no market volatility
S&P 500 is falling the VIX is
rising
High levels of VIX
indicates heightened investor fear
Increasing levels of volatility will increase the VIX value
so buy VIX calls or sell VIX puts.
Decreasing levels of volatility will lower the VIX value
so buy VIX puts or sell VIX calls.
Interest rate index option premium movements
based on the movement of market interest rates.
13 week Treasury Bill
IRX
5 year Treasury Note
FVX
10 year Treasury Note
TNX
30 year Treasury Bond
TYX
rising interest rates
BUY CALLS SELL PUTS
falling interest rates
either buy puts or sell calls
spot market
sttlement/ delivery in 1 or 2 business days
forward contract
settlement usually longer than spot months away
Country feels that their money is overvalued they will
sell its currency in the mark
contry feels that their money is undervalued they will
buy the currency in the market
as countrys strength increase, interest rate rise
currency rises
as country weakens, interest rates fall,
currency falls
options of foreign currency trade on the
philadelphia stock exchange
if you believe that a currency will strengthen
buy calls
if you believe that a currency will weaken
buy puts
The major currency options traded on the PHLX
British Pound Euro Japanese Yen Swiss Franc Canadian Dollar Australian Dollar
contract size for all the currencies except yens
10,000
contract size for yens
1,000,000,000
foreign currency are what type of option
european style, settle next business day and can be exercised only at expiration
