Options - Hedging

Question 1

Why hedge? 195

Answer 1

Options can be used to protect a stock position

Question 2

What is a spread 201

Answer 2

Simultaneous purchase of one option and sale of another option of same class:
Call spread - make long and short call
Put Spread - make a long and short put

Question 3

What are 3 types of spreads? 201

Answer 3

Strike Price Expiration Date
Price/Vertical Spread Different Same
Time or Calendar/
Horizontal Same Different
Diagonal Different Diffferent

Question 4

When use Horizontal Spread 201

Answer 4

Horizontal spread used if:

1. Don’t expect a lot of volatility
2. Profit from different rates w time value

Question 5

Types of Diagonal Spread 201

Answer 5

1. Debit Call Spread:
2. Credit Call Spread:
3. Debit Put Spread
4. Credit Put Spread

Question 6

What is a Collar? 198

Answer 6

Hedging downside risk on a long position of stock for no out of pocket cash
Also known as ‘cashless collar’
e.g. Investor is long @50, buys put 45, and sells call 55 with premium of 3. Then has +3 and -3 premium.

Question 7

What is ratio call writing 198

Answer 7

Sell more calls than the long position covers. Generates additional premium income but has unlimited risk because of the short uncovered calls