Reading 6

Question 1

European versus American style options

Answer 1

European: can be exercised at the point of expiration
American: may be exercised on any trading day up to and including point of expoiration

Question 2

Determinants of an option’s value

Answer 2

1. strike price
2. current level of the underlying
3. remaining time to expiration
4. volatility of the underlying (implied, not the same at historical)
5. annualized risk free interest rate over the period to expiration
6. annualized yie;d expected from the underlying
7. whether european or american

Question 3

How are volatility and expiry related t option premium?

Answer 3

• higher volatility means higher option premium for both calls and puts
• Less time to expiry means lower option premium for both calls and puts

Question 4

Naked/ uncovered call

Answer 4

When a call is sold without any hedging position in place

Question 5

Breakeven for call

Answer 5

value = premium paid

Question 6

How do you create a synesthetic long forward?

Answer 6

Long call and short put on the same underlying and same strike and expiration

Question 7

What is the breakeven point for a synthetic long forward?

Answer 7

strike + net premium paid

Question 8

Put-call parity relationship

Answer 8

S + P = C + PV(X)

Question 9

Put-call forward parity relationship

Answer 9

PV (FT) + P = C + PV(X)

Question 10

If investor is long a stock that they think has limited upside, which position should they enter?

Answer 10

Covered call

Question 11

What is covered call?

Answer 11

Long Underlying + Short Call

Risk of short position is hedged away by ownership of the stock

Question 12

What is the breakeven for a covered call?

Answer 12

Same as maximum loss = S - C

Question 13

What are the reasons to use a covered call strategy?

Answer 13

1. For yield enhancement: calls are OTM (substantially so)
2. For reducing position at a favorable price (calls are ITM)
3. For target price realization (calls are marginally OTM)

Question 14

covered calls for yield enhancement - OTM or ITM?

Answer 14

subsantially OTM

Question 15

Covered call for reducing position at favorable price - OTM or ITM?

Answer 15

ITM

Question 16

covered call for target price realization - OTM or ITM?

Answer 16

Marginally OTM

Question 17

Protective Put

Answer 17

Long underlying + long put

Question 18

What is a collar

Answer 18

protective put + covered call

Long underlying + long OTM put + short OTM call

Question 19

Long Straddle

Answer 19

Volatility play

Long straddle: purchase of an equal number of calls and puts on a given underlying. the options have the same expiry and strike.

Question 20

Short Straddle

Answer 20

Neutrality play

Selling, instead of buying equal number of calls and puts

makes more profit the closer to the strike the underlying ends up, with no limit on potential loss

Question 21

Bull spreads

Answer 21

Long the low strike, short the high strike

Question 22

Bear spreads

Answer 22

short the low strike, long the high strike

Question 23

What are debit and credit spreads?

Answer 23

Debit Spreads: net outflow of premium (bull call and bear put)

Credit Spreads: net inflow of premium (bear call and bull put)

Question 24

What are the debit spreads?

Answer 24

Bull call and bear put

Question 25

What is the maximum profit and loss on debit spreads?

Answer 25

Maximum profit = difference between strikes - net premium paid

Maximum loss = net premium paid

Question 26

What are credit sireads?

Answer 26

Bear call and bull put

Question 27

What is the maximum profit and loss on a credit soread?

Answer 27

Maximum profit = net premium received

Maximum loss = difference between strikes - net premium received

Question 28

What is the breakeven for call and put spreads?

Answer 28

Call spreads = lower strike + net premium

Put spreads = higher strike - net premium

Question 29

Gamma

Answer 29

Change in option delta per one unit change in stock price

Positive for long calls and for long puts

Question 30

Delta

Answer 30

Change in option price per 1 unit change in stock price

Positive for long calls and negative for long puts

Question 31

Theta

Answer 31

Daily change in option price (effect of time passing)

Theta is negative for long calls and long puts

Question 32

Vega

Answer 32

Change in option price per 1% change in volatility

Vega is positive for long calls and long puts

Question 33

What is the general rules for delta?

Answer 33

The more ITM an option is , the higher is its absolute delta (closer to 1)

The more OTM an option is, the lower its absolute delta (closer to 0)

Question 34

When is Gamma highest?

Answer 34

tends to be higher the closer to AtM options and is highest the for ATM options closer to expiration

Question 35

Which strategy do you choose when you want to remain invested in a stock but also want protection against downside in the short term?

Answer 35

Protective Put

Question 36

Which strategy do you pick if you want to profit from a large price move in either direction, do not currently own the stock, and are unsure which direction the stock price will move?

Answer 36

Straddle

Question 37

Answer this question

Answer 37

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