Principles of exchange traded derivatives Flashcards
If the future’s price is trading above its fair value, which of the following trades is most likely to take advantage of this discrepancy?
ASell the underlying asset BSell futures CCash and carry DReverse cash and carry
Cash and carry,
Buying the underlying asset in the cash market and simultaneously selling the futures contract would exploit the difference between the two. This is known as cash and carry arbitrage. If the futures price was trading BELOW fair value then reverse cash and carry arbitrage would exploit the price differential.
A three-month call option with a strike price of $30 is trading at $3. A three-month put option with a strike of $30 is trading at $2.75. The underlying stock is priced at $31 and interest rates are 12%. What is the net profit available to an arbitrageur according to put/call parity theory?
A$0.75 B$1.59 C$1.74 D$2.25
$1.59,
This requires an application of put-call parity theorem.
C - P = S - K/(1+r)^t
3 - 2.75 = 31- 30/(1+0.12)^0.25. So 0.25 should be equal to 1.84 and it clearly is not. Profit available therefore 1.84 - 0.25 = $1.59.
Which of the following options would have the highest delta?
AA far-dated deeply out-of-the-money call BA near-dated deeply out-of-the-money put CA near dated at-the-money call DA far-dated deeply in the money put
A far-dated deeply in the money put,
In the money options have the highest delta.
It is the convention to ignore the sign - therefore -1 and +1 are treated in the same way.
Exchange price feeds provide:
ADelayed prices BStreaming prices CSettlement prices DClosing prices
Streaming prices ,
Exchange price feed provide streaming prices throughout the day.
The rate of change of delta (assuming long positions) for a given change in the underlying is:
APositive for calls, negative for puts BPositive for calls, positive for puts CNegative for calls, negative for puts DNegative for calls, positive for puts
Positive for calls, positive for puts
What is the time value for a put option with a strike of £1.20 and a premium of 20p when the underlying is trading at £1.02?
A20p B18p C2p DNil
2p,
Time value = premium - intrinsic value.
Intrinsic value for a put = strike - underlying asset value = 1.20 - 1.02 = 18p.
Therefore time value = 2p.
A wheat farmer fears falling prices will affect the return from his harvest, so he enters into a short futures contract on exchange to reduce his risk. At harvest, the farmer sells his wheat and closes out his futures position. What risk is he exposed to?
ACounterparty risk BMarket risk CDefault risk DBasis risk
Basis risk,
In this question, we have to assume that the farmer is closing out his position and lifting his hedge early. In this case, he is exposed if the relationship between the cash and futures price has changed: i.e. if the basis has changed.
If a future was trading BELOW its fair value, what would you expect a futures trader to do?
ACash and carry arbitrage BA spread trade CReverse cash and carry arbitrage DReversal
Reverse cash and carry arbitrage,
Reverse cash and carry = BUY the future and SELL the cash asset. Note: If the future was trading ABOVE its fair value, cash and carry arbitrage would occur, i.e. the cash asset would be bought and the future sold.
In a screen-based market, the exchange has a responsibility to provide prices to which of the following people?
AQuote vendors BExchange members CThe public DThe clearing house
The public ,
Exchanges must publish trading information giving everyone access to price and volume information. This publication of trade details is a requirement for all ‘on exchange’ transactions, whether they occur through screen trading or not.
An investor who sells the expensive contract and takes an offsetting position in the cash market is undertaking which of the following trades?
ASelling basis BCost-of-carry CReverse cash and carry DCash/Futures arbitrage
Cash/Futures arbitrage,
The best answer would be Cash and Carry arbitrage but this is not available.
Given the choice the correct answer is Cash/Futures arbitrage. Cash/Future arbitrage is a generic term that can be used to describe a Cash and Carry arbitrage OR a Reverse Cash and Carry arbitrage.
Cash and carry: buy cash, sell future. Reverse cash and carry: sell cash and buy the future.
The Delta of a deeply in-the-money short-call is:
AZero BClose to 1 CClose to -1 D0.5
Close to -1,
Delta measures the relationship between option premiums and the price of the underlying.
Deeply ITM long-calls / short-puts have Deltas of close to 1.
Deeply ITM short-calls / long-puts have Deltas of close to -1
An option’s Delta is best described as the ratio between:
AThe price of the option and the price of the underlying instrument BThe change in the option premium and the change in the price of the underlying instrument CThe time value and the intrinsic value DThe option premium and the underlying price
The change in the option premium and the change in the price of the underlying instrument,
The Delta of an option quantifies how far a premium changes given a change in the price of the underlying asset. Note: Delta = change in premium / change in underlying.
