Unit 3 Flashcards
What is a contract that derives its value from an underlying asset?
A Derivative
What are the two parties that consist in a derivative?
A buyer and a seller
Derivatives are most often used for which types of assets?
Commodities
What is based on the value of a foreign currency versus the US dollar?
Currencies
What type of assets derives from that of an underlying instrument such as a stock, stock index, interest rate or foreign currency?
Options
What type of asset is not considered classified?
Futures
Which party in a option has the right to exercise the contract to buy or sell?
The buyer
Which party in an option is obligated to fulfill the terms of the contract?
The seller
What does the buyer risk in options?
Losing the premium paid for the contract if the option expires as worthless
What is the beginning step for the buyer and what is the second transaction?
Opening purchase»»>closing Sale
What does the seller profit from in a option?
The amount of premium received for the contract if the option expires as worthless.
What is the beginning step for the seller and what is the second transaction?
Opening sale»»>Closing purchase
List the characteristics of a buyer:
- Purchaser or holder
- Long
- Pays Premium
- Owns the right
- Is in control
List the characteristics of a seller:
- Writer
- Short
- Received premium
- Takes on obligation
What are the four basic transactions available to an option investor?
- Buy calls
- Sell calls
- Buy puts
- Sell puts
Buy Calls = Go ____
Long
Sell Calls = Go _____
Short
This is when a call buyer owns the right to buy 100 shares of a specific stock at the strike price before the expiration if he chooses to exercise the contract.
Buyer is bullish (anticipates security will rise)
Long Call (purchase)
Provide descriptions for the following:
Long, XYZ, Jan, 60, Call, 3
- Long - investor has bought the call and has the right to exercise
- Represents amount of shares
- Contract expires on the third Friday of Jan
- Strike price
- Type of option. Investor has right to buy the stock at 60 because he is long the call
- Premium (Issued with 100 shares)
Buyers of calls want the market price of the underlying stock to ____.
Rise
This is when a writer has the obligation to sell 100 shares of the specific stock at the strike price if the buyer exercises the contract.
Writer is bearish (anticipates the security will fall)
Short Call (Sale)
Provide descriptions for the following:
Short, XYZ, Jan, 60, Call, 3
- Short - Investor has sold the call and has obligations to perform if the contract is exercised
- Represents amount of shares
- Contract expires on the third Friday of Jan. If expiration occurs, the writer keeps the premium without any obligation.
- Strike price
- Type of option. Obligated to sell the stock at 60, if exercised because he is short call
- Premium (Issued with 100 shares)
Writers (sellers) of calls want the market price of the underlying stock to ____.
Fall or remain the same
What does the writer keep if the contract is unexercised by the time it expires?
The premium
Buy Puts = Go ____
Long
Sell Puts = Go _____
Short
This occurs when a buyer owns the rights to sell 100 shares of a specific stock at the strike price before the expiration if he chooses to exercise the contract.
Bearish investor (anticipates the security will fall)
Long put (purchase)
Provide descriptions for the following:
Long, XYZ, Jan, 60, Put, 3
- Long - Investor has bought the put and has the right to exercise
- Represents share amount
- The contract expires on the third Friday of Jan
- Strike Price
- Type of option. Investor has the right to sell the stock at 60, because he is long put
- Premium (Issued with 100 shares)
Buyers of put want the market price of the underlying stock to ____.
Fall
This occurs when a writer has the obligations to buy 100 shares of a specific stock at the strike price if the buyer exercises the contract.
Bullish Investor who wants the security to rise or remain the same.
Short put (sale)
Provide descriptions for the following:
Short, XYZ, Jan, 60, Put, 3
- Short - Investor has sold the put and has obligations to perform if the contract is exercised.
- Represents share amount
- The contract expires on the third Friday of Jen. If expirations occurs, the writer keeps the premium without any obligation
- Strike Price
- Premium (Issued with 100 shares)
A call buyer is a _____ investor because he wants the market to rise.
Bullish
A call buyer is exercised only if the market price ___ ___ the strike price.
Rises above
A call write is a ___ investor because he wants the market to fall.
Bearish
A call writer’s contract is not exercised if the market prices ____ ____ the strike price
Falls below
A put buyer is a ____ investor because he wants the market to fall.
Bearish
A put is exercised only if the market price ____ ____ the strike price.
Falls below
A put writer is a ____ investor because he wants the market to rise or remain the same.
Bullish
The contract for a put writer is not exercised if the market price ____ ____ the strike price.
Rises above
This type of option tracks the performance of a particular group of stocks.
If exercised, no delivery of the underlying shares is made. The writer pays the options owner the differential in cash.
Index options
This was created to measure expected volatility of the US stock market and is based on pricing from S&P 500 index.
Used to speculate on volatility of the equity markers.
Also known as “Fear Index”
Tends to spike upward when the stock market experiences a severe downdraft.
VIX options
Which type of option settles in cash with European exercise provisions?
VIX options
A call is ____ when the price of the stock exceeds the strike price of the call. A buyer will exercise calls.
In the money
A call is ____ when the price of the stock equals the strike price of the call. A buyer will not exercise.
At the money
A call is ____ when the price of the stock is lower than the strike price of the call. A buyer will not exercise.
Out of the money
A buyer wants ____ for calls. A seller does not.
In the money
A seller wants ____ for calls. A buyer does not.
At the money
A seller wants ____ for calls. A buyer does not.
Out of the money
____ _____ is the same as the amount a contract is in the money. A call has ____ ____ when the market price of the stock is ____ the strike price of the call.
This can never be negative. Its always a positive number or zero.
- Intrinsic Value
- Intrinsic Value
- Above
Options that are at the money or out of the money have an intrinsic value of ____.
Zero
____ like calls to have intrinsic value. ____ do not.
- Buyers
2. Sellers
A call that has no intrinsic value will simple be allowed to ____.
Expire
____ want the contract to move in the money for calls. ____ want the contract to move out of the money.
- Buyers
2. Sellers
A put is _____ when the price of the stock is lower than the strike price of the put. Buyer will exercise.
In the money
A put is ____ when the price of the stock equals the strike price of the put. Buyer will not exercise.
At the money
A put is _____ when the price of the stock is higher than the strike price of the put. Buyer will not exercise.
Out of the money
A buyer wants ___ for puts. A seller does not.
In the money
A seller wants ___ for puts. A buyer does not.
At the money
A seller wants ___ for puts. A buyer does not.
Out of the money
A put has intrinsic value when the market price of the stock ___ ____ the strike price of the put.
Falls below
A put that has intrinsic value will be _____
Exercised
A put option has ____ when the premium equals intrinsic value.
Parity
What two part make up a premium of an option?
Intrinsic value and time value
What is the math calculation to determine a premium?
IV + TV = Pr
The IV value is an ____ number.
Objective
TV is a ____ number.
Subjective
This is a subjective number that is determined by ____ and ____.
- TV
2. Supply and demand
What are the two factors that affect time value?
- The amount of time to expiration
2. Volatility
The more ___ until expiration, the more time value a given option will have.
Time
The more ____ the underlying asset’s price, the more time value in the ____ .
- Volatile
2. Premium
These types of assets function nearly the same as equity options, but because the underlying instruments are not shares of stocks, nonequity options have different contract sizes and delivery and exercise standards.
Nonequity (currency and index) options
Options on ____ allow investors to profit from the movements of markets or market segments and hedge against these market swings.
Indexes
These reflect movement of the entire market and include S&P 100, S&P 500 and the major market index.
Broad based indexes
These track the movement of market segments in a specific industry, such as technology or pharmaceuticals.
Narrow based indexes
This is a measure of the implied volatility of the S&P 500 Index options traded on the CBOE. They are designed to reflect investor expectations of market volatility over the next 30 days. Often called “fear” gauge or index. Measure of fear/expectation.
VIX Index (Volatility Index)
What is the multiplier for index options?
$100
How is the option’s cost calculated on index options?
Premium amount is multiplied by $100
How is the total dollar value of the index calculated on index options?
Strike price is multiplied by $100
When do index options settle?
The next business day
When do index options stop trading?
4:15pm ET if they are broad based. 4:00pm ET if narrow
How do index options settle?
In cash instead of in a security. Cash must be delivered on the next business day.
The writer of the option delivers cash equal to the ____ of the option to the buyer for index options
Intrinsic value
When indexed options are exercised, their ____ ____ is based on the ___ ____ of the index on the day of exercise, not the value at the time of exercise.
- Settlement price
2. Closing value
When do index options expire?
The third Friday of the expiration month.
What is the one major difference between index options and equity options?
The exercise of an index options settles next business days, whereas the exercise of an equity option settles two business days.
A customer buys 1 OEX Jan 460 call at 3:20 when the OEX index is trading at 461. What is the premium?
$320 (3.20 x $100)
A customer buys 1 OEX Jan 460 call at 3:20 when the OEX index is trading at 461. What is the breakeven point?
463.20 (strike price + premium)
A customer buys 1 OEX Jan 460 call at 3:20 when the OEX index is trading at 461. What is the intrinsic value?
$100 (461-460)
A customer buys 1 OEX Jan 460 call at 3:20 when the OEX index is trading at 461. What is the time value?
$220 (320-100)
If an investor believe the market will ____ he can purchase index calls or write index puts.
Rise
If an investor believes the market will ____, he can purchase index puts or write index calls.
Fall
___ ____ ___ are yield based.
Interest rate options
What are interest rate options based on?
T-Bills, T-Notes and T-Bonds
If a portfolio manager believes rates will ____, the manager will by puts or write calls for interest rate options.
Fall
If a portfolio manager believes rates will rise, ___ ____ & ____ _____ would be appropriate for interest rate options.
- Fall
2. Buying calls and writing puts
All yield based options are
European style exercise. May only be exercised on expiration day.
This allows investors to speculate on the performance of currencies other than the US dollar or to protect against fluctuating currency exchange rates against the US dollar.
Currency options
Currency options are available for trading on US listed exchanges on the ____ ____.
Australian dollar, British pound, Canadian dollar, Swiss francs, Japanese yen and the euro.
Why do importers and exporters use currency options?
To hedge currency risk and to hedge fluctuations in currency exchange rates
When do currency options expire?
The third Friday of the expiration month
When do currency options settle?
The next business day
What type of style is a currency option?
European style exercise only.
What is EPIC?
Exporters buy Puts
Importers buy Calls
This allows the owner of a contract to exercise anytime before expiration.
American-Style Rules
____ ____ options can be exercised only on expiration day.
European-Style
The point at which the investor neither makes nor loses money.
The BE point
____ or ____ has to do with the market attitude of the position (bearish or bullish)
MG or ML
For Long Calls, the BE is found by ___ the strike price and the premium. For the buyer, the contract is profitable ___ the BE.
- Adding
2. Above
For Long Calls, the __ is unlimited because there is no limit on how far a stocks price can rise. Potential gain is unlimited.
MG
For Long Calls, ML, the most the call buyer can lose is the ____. This will happen if the stock price ___ ___ or ____ the strike price of the option at expiration
- Premium
2. Is at or below
For Short Calls, the BE is found by ____ the strike price to the premium. For the call ____ the contract is profitable ___ the BE.
- Adding
- Seller
- Below
For Short Calls, MG - A writer’s MG is the ____ _____. The MG is earned when the stock prices __ ____ or ____ the exercise price at expiration.
- Premium received
2. Are at or below
For Short Calls, a call writer’s ML is
Unlimited
For Long Puts, the BE is found by ____ the premium from the strike price. Investor can profit from a ___ in a stock’s price.
- Subtracting
2. Decrease
For Long Puts, the MG is the maximum potential gain available to put owners is the option’s ___ ____ less the amount of the ____ paid.
- Strike price
2. Premium
For Long Puts, (ML) the most the put buyer can lose is the ___ paid. This happens if the market price ___ ___ or ____ the strike price.
- Premium
2. Is at or above
For Short Puts, the BE is found by ____ the premium from the strike price. For the put seller, the contract is profitable __ or ___ the BE at expiration
- Subtracting
2. At or above
For Short Puts, a put writer’s MG is the ____ received. The MG is earned when the stock price __ ___ or ___ the exercise price at expiration.
- Premium
2. Is at or above
A put writer’s ML is the ___ ____ ___ less the ____ ____
- Puts strike price
2. Premium received
Investors use options to hedge a long or short stock position. They use options as an ___ _____ in the event their core stock position moves it the wrong direction.
Insurance policy
The insurance policy profits if the core stock moves in the ___ ____.
Wrong direction
This put option is bought as a hedge when the stock is falling in value.
Protective puts
Protective puts ___ ___ a minimum sales price if the long term position moves in the wrong way.
Locks in
What two parts are used to calculate the breakeven of a protective put?
A long stock and a long put
What needs to happen in order for the customer to break even on a protective put?
The value of the stock the customer owns must rise above what he paid for the stock by enough to cover the cost of the option position.
What is the formula for breakevens with protective puts?
breakeven = stock price + premium
This ensures that the client could buy the stock back at no more than the options strike price if the shares rise in value.
Protective calls
Protective calls locks in a ___ ____ ____ to cover the short if the short position moves the wrong way.
Maximum purchase price
A short stock position has ____ risk.
Unlimited
What controls the risk of selling a stock short?
Protective calls
What two parts are used to calculate the breakeven of a protective call?
A short stock and a long call
In order for a customer to breakeven on a call, the value of the stock the customer shorted must ___ ____ what she paid for the stock by enough to cover the cost of the option position.
Fall below
What is the formula to calculate breakevens for protective calls?
Breakeven = stock price - premium
With calls risk is _____.
Unlimited
When writing puts, the risk is ___ ____.
Not unlimited
When speaking of ___ or ____, we are speaking to the writer’s option position and whether or not the writer already owns the underlying security to be delivers in the event that the owner exercises the contract. (For calls)
Covered or uncovered
The option is ____ when the writer already owns the underlying security. This ensures the writer’s ability to perform, should the owner exercise the contract. (For calls)
Covered
If the contract is ____, the writer does not own the underlying security. If the contract is exercised by the owner, the writer will need to purchase the underlying security at the current market price to deliver it. (For calls)
Uncovered
Uncovered contracts have more
Risk
If the contract is ____ the writer already has sufficient cash available to buy the stock. This ensures the writer’s ability to perform, should the owner exercise the contract (For puts)
Covered
If the contract is ____, the writer does not have the cash on hand to purchase the stock at the stock price. The writer will need to come up with the cash from somewhere (For puts)
Uncovered
This is when a customer is short the stock and writes the put
Covered against a short stock
What are the primary regulators for options?
OCC and the CBOE
The ___ provides an options disclosure document (ODD) which must be provided at or before the time of the account approval.
OCC
What does the ODD entail?
Explains options strategies, risks and rewards and is designed to provide full and fair disclosure to customers before they begin options trading.
Who approves an options account?
ROP
A representative provides a customer a copy of the ___
ODD
When does the customer need to return the signed ODD?
No later than 15 days after the account approval
What happens if the customer does not return the ODD within 15 days?
Only closing transactions are allowed
This is the clearing agent for listed options contracts that are listed for trading on US options exchanges.
OCC
The ___ determines when new option contracts should be offered to the market on an underlying security. It designates the contract specifications.
OCC
What are the trading times for options?
9:30-4:00pm ET
What is the settlement for options?
The next business day after trade dat (T+1)
When do options expire?
The third Friday of the expiration month at 11:59pm
When can options be exercised?
From the time of purchase until they expire
Any contract that is in the money by at least 0.01 will be exercise _____ at expiration for the holder unless the holder gives do not exercise instructions.
Automatically
The OCC assigns exercise notices to short BDs on a ___ basis
Random
BDs may assign exercise notices to their short customers on a random basis or on a ___ basis.
FIFO
Options contracts are traded without a _____.
Certificate
What is proof of ownership for an investor of an options?
Trade confirmation
The owner of a ___ has the right to buy the stock at the strike price. The owner must exercise it. The writer will then be assigned meaning that the writer must now fulfill her obligation to sell the stock at the strike price
Call
The owner of a ___ has the right to sell the stock at the strike price. The must must exercise it. The writer will be assigned meaning that the writer must now fulfill her obligation to buy the stock at the strike price.
Put
