Part 1 Lesson 2.2: Investment Strategies Flashcards
Options, events
Option events
- The owner (holder) of a put or call option contract has three choices before the expiration of the contract:
1. Exercise the option.
2. Let the option expire.
3. Sell the option.
• Most brokerage firms have an earlier cut-off time for submitting exercise instructions.
Common objectives of call buyers
Call buyers are bullish on the underlying stock:
• Speculative profit
• Deferring a decision
• Diversifying holdings
Common objectives of call writers
Common objectives of call writers
- Call writers are generally neutral on the underlying stock:
• Increasing yield
• Lock in a sale price
Common objectives of put buyers
Common objectives of put buyers
- Put buyers are generally bearish:
• Speculating on a decline
• Defer a decision
• Protect a position
Common objectives of put writers
Common objectives of put writers
- Put writers are neutral to bullish.
- Put writers assume much greater risks than put buyers.
- This is a good way to buy the stock at a cost lowered by the amount of the time premium received.
Investment Strategies
Question 1
A customer who is long stock wants to hedge her risk in the position while bringing some income into her account.
Which of the following would be the appropriate hedge to align with the customer’s investment objective?
A. Long calls
B. Long puts
C. Short calls
D. Short puts
Answer C
Probably the most used income strategy is the selling (writing) of calls against an existing long stock position of the stock. Covered call writers also reduce the downside risk.
Investment Strategies
Question 2
A customer sells short 1,000 MCS at $30 per share. To best hedge against loss, the customer should
A. write 10 MCS puts.
B. buy 10 MCS calls.
C. buy 10 MCS puts.
D. write 10 MCS calls.
Answer B
Because there is no limit on how high the stock price can rise, there is no limit on the short seller’s loss potential.
Because of the risk, some investors hedge their short stock positions by buying call options. If the stock price does move against the investor by rising, he can exercise the right to buy shares of that stock at the strike price.
Investment Strategies
Question 3
At expiration, the market price of the underlying stock is the same as the strike price of the option. Which of these positions result in a profit?
1. Short call
II. Long call Ill. Short put IV. Long put
A. I and III
B. I and IV
C. Il and Ill
D. Il and IV
Answer A
If a short call and a short put at expiration are not exercised, the premium is kept by the writer.
Investment Strategies
Question 4
Covered call writing normally occurs in
A. a rising market.
B. a falling market.
C. a volatile market.
D. a stable market.
Answer D
Covered call writing is most effective in a stable market where the stock position is not expected to move much. It is not a suitable strategy in a rising or falling market.
Call Options - Buy
When you buy a call, it gives you the right (but not the obligation) to buy a specific stock at a specific price per share within a specific time frame. A good way to remember this is: you have the right to “call” the stock away from somebody.
Call Options - Sell
If you sell a call, you have the obligation to sell the stock at a specific price per share within a specific time frame — that’s only if the call buyer decides to invoke their right to buy the stock at that price.
Put Options - Buy
When you buy a put, it gives you the right (but not the obligation) to sell a specific stock at a specific price per share within a specific time frame. A good way to remember this is: you have the right to “put” stock to somebody.
Put Options -Sell
If you sell a put, you have the obligation to buy the stock at a specific price per share within a specific time frame — that’s only if the put buyer decides to invoke their right to sell the stock at that price.
Covered Call
The Setup
•You own the stock.
•Sell a call, strike price A
•Generally, the stock price will be below strike A
When to Run?
•Neutral to Bullish.
•Willing to sell the stock if it reaches a specific price.
Break Even at Expiration
• Current stock price minus the premium received for selling the call.
The Protective Put
The Setup
• you own the stock
• buy a put strike price a
• generally the stock price will be above strike a
When to run it
• Your bullish, but nervous
• from the point the protective foot is established the brick even point is the current stock price plus the premium paid for the put.
