Reading 6 Flashcards
Options Strategies
European versus American style options
European: can be exercised at the point of expiration
American: may be exercised on any trading day up to and including point of expoiration
Determinants of an option’s value
- strike price
- current level of the underlying
- remaining time to expiration
- volatility of the underlying (implied, not the same at historical)
- annualized risk free interest rate over the period to expiration
- annualized yie;d expected from the underlying
- whether european or american
How are volatility and expiry related t option premium?
- higher volatility means higher option premium for both calls and puts
- Less time to expiry means lower option premium for both calls and puts
Naked/ uncovered call
When a call is sold without any hedging position in place
Breakeven for call
value = premium paid
How do you create a synesthetic long forward?
Long call and short put on the same underlying and same strike and expiration
What is the breakeven point for a synthetic long forward?
strike + net premium paid
Put-call parity relationship
S + P = C + PV(X)
Put-call forward parity relationship
PV (FT) + P = C + PV(X)
If investor is long a stock that they think has limited upside, which position should they enter?
Covered call
What is covered call?
Long Underlying + Short Call
Risk of short position is hedged away by ownership of the stock
What is the breakeven for a covered call?
Same as maximum loss = S - C
What are the reasons to use a covered call strategy?
- For yield enhancement: calls are OTM (substantially so)
- For reducing position at a favorable price (calls are ITM)
- For target price realization (calls are marginally OTM)
covered calls for yield enhancement - OTM or ITM?
subsantially OTM
Covered call for reducing position at favorable price - OTM or ITM?
ITM
covered call for target price realization - OTM or ITM?
Marginally OTM
Protective Put
Long underlying + long put
What is a collar
protective put + covered call
Long underlying + long OTM put + short OTM call
Long Straddle
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.
Short Straddle
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
Bull spreads
Long the low strike, short the high strike
Bear spreads
short the low strike, long the high strike
What are debit and credit spreads?
Debit Spreads: net outflow of premium (bull call and bear put)
Credit Spreads: net inflow of premium (bear call and bull put)
What are the debit spreads?
Bull call and bear put
What is the maximum profit and loss on debit spreads?
Maximum profit = difference between strikes - net premium paid
Maximum loss = net premium paid
What are credit sireads?
Bear call and bull put
What is the maximum profit and loss on a credit soread?
Maximum profit = net premium received
Maximum loss = difference between strikes - net premium received
What is the breakeven for call and put spreads?
Call spreads = lower strike + net premium
Put spreads = higher strike - net premium
Gamma
Change in option delta per one unit change in stock price
Positive for long calls and for long puts
Delta
Change in option price per 1 unit change in stock price
Positive for long calls and negative for long puts
Theta
Daily change in option price (effect of time passing)
Theta is negative for long calls and long puts
Vega
Change in option price per 1% change in volatility
Vega is positive for long calls and long puts
What is the general rules for delta?
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)
When is Gamma highest?
tends to be higher the closer to AtM options and is highest the for ATM options closer to expiration
Which strategy do you choose when you want to remain invested in a stock but also want protection against downside in the short term?
Protective Put
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?
Straddle
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