Section II.E.

Question 1

What are options?

Answer 1

• Call: Right to buy underlying asset at the strike or exercise price.
  – Value of calls decrease as strike price increases
• Put: Right to sell underlying asset at the strike or exercise price.
  – Value of puts increase with strike price
• Value of both calls and puts increase with time until expiration.

Question 2

What is Put/Call Parity?

Answer 2

• defines the relationship between a European put option and a European call option where the strike prices and expiration are identical
• it is expected (given certain assumptions) that the value of a long call option and a short put option is equal to a single forward contract as the same strike price and expiration

Question 3

What is a protective put?

Answer 3

• a strategy where an investor buys put option (protection) on the same stock the he owns thus allowing potentially unlimited upside with limited downside
• also called a “married put”

Question 4

What is Put writing?

Answer 4

• a strategy where an investor writes (sells) a put contract and receives income in exchange for committing to buy shares at the strike price if the contract is exercised

Question 5

What are covered calls?

Answer 5

• an options strategy where one buys stock and sells a call option against those shares in exchange for income

Question 6

What are some conclusions we can make about Protective Puts?

Answer 6

• Puts can be used as insurance against stock price declines.
• Protective puts lock in a minimum portfolio value.
• The cost of the insurance is the put premium.
• Options can be used for risk management, not just for speculation.

Question 7

What are some conclusions we can make about Covered Calls?

Answer 7

• Purchase stock and write calls against it.
• Call writer gives up any stock value above X in return for the initial premium.
• If you planned to sell the stock when the price rises above X anyway, the call imposes “sell discipline.”