Unit 3 - Derivatives Flashcards
These are contracts between two or more parties where the _____ value is based upon an underlying financial asset or a set of assets.
Derivative contracts.
______ are derivatives that have a commodity as the underlying asset. _____ are not classified as securities
Futures
The amount paid for the contract when purchased, or received for the contract when it was sold is called the ______ ?
Premium
Considered the buyer ( owner of the contract) who pays the premium for the contract is often called what?
Long the contract
Buyer’s (Holder’s)
Begin the process with opening purchase of the contract (pay the premium)
Buyer’s
If the buyer decides to sell the contract later, the second transaction is called the?
Closing sale
Often called the writer of the contract or
Short the contract
Seller
______ can potentially profit if the contract option expires as worthless.
Party short the contract
Sellers (Writer’s)
If the writer (short the contract) decides to buy back the contract later, the second transaction is called
A closing purchase
A buyer of options is often referred to as taking a __________ position
Long position
When the market price is above the strike price, this investor will exercise the contract.
Long call (call buyer)
Bullish investor
A _____ has the obligation to sell x amount of shares of a specific stock at the strike price if the buyer exercises the contract?
Short call or call writer?
Often referred to as a bearish investor
Anticipates that the price of the underlying security will fall
Short call or call writer
Receives the premium for the contract. And if the contract is unexerced by the time it expires, the _____ keeps the premium with no further obligation
The writer aka the seller
Buyers of ___ want the market price of the other underlying stock to fall
Puts
Has the obligation to buy x amount of shares at the strike price if the buyer exercises the contract?
Put writer.
Short put position.
is a financial agreement between two parties that derives its value from an underlying asset, such as a commodity, stock, bond, or currency.
- are used for a variety of purposes, including hedging against price fluctuations, speculating on future prices, and managing risk in financial portfolios.
- traded on exchanges or over-the-counter (OTC) markets and can involve significant amounts of leverage and risk.
Derivative contracts
_____ are derivate securities. They derivice their value from the underlying assets
Options
Is a 2 party contract, meaning that there are 2 parties involved in the contract
One has the right to buy or sell the underlying security and the other
Is obligated to fulfill the terms of the contract a
An option
Purchaser
Or holder
Long
Pays premium
Owns the right
Is in control
Buyer
the common options are those issued on common stock, referred to as ?
Equity options
Writer
Short
Receives premium
Takes on obligation
Seller
Investors can either ___ or ___ calls and puts
Buy, sell
______ the contract purchases 100 shares of stock at the strike price (exercise price). The investor is ____ the contract.
Exercising the contract.
Long the contract.
This type of investor anticipates that the price of the underlying security will rise
Bullish investor
What type of investor is a call writer (seller) ?
Bearish
Because the seller anticipates the price of the underlying security will fall
What type of investor is a long call (buyer) ?
Bullish
Because he anticipates the price of the underlying security will rise
Buyers of ___ want the market price of the underlying stock to fall
Puts
Because if the price falls below the exercise price they have made more back versus what the stock is worth when they exercise the contract
___ writer (seller) has the obligation to buy 100 shares of a specific stock at the strike price if the buyer exercises the contract
Put writer
Put seller wants the price of the underlying stock to rise or remain the same
So the buyer doesn’t exercise the contract and the premium is retained without obligation
What is the basic formula for an option premium?
Intrinsic value + time value
(IV + TV = Pr)
A put has ________ when the market price of the stock is below the strike price of the put
Intrinsic value
Remember. Strike price for a put is the price the seller is obligated to buy at
So, if the market price is lowe than the strike price, the buyer makes a profit.
He is selling the stock higher than what it is valued
A put is ____ the money when the price of the stock is lower than the strike price of the put.
In the money
A put is _____ when the premium equals intrinsic value
At parity
A call is ____ the money when the price of the stock equals the strike price of the call
At the money
A call is ____ the money when the price of the stock exceeds (is higher) the strike price of the call
In the money
A call is _____ the money when the price of the stock is lower than the strike price of the call
Out of the money
An options contract is general for ____ shares
100
Is a subjective number which derives it’s value based off supply & demand.
Time Value
Predetermined price at which the buyer of the put option can sell the underlying security is called ___
Strike price
Give holders of the option the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame
Put options
____ options increase in value as the underlying asset falls in price
Put
Gives the holder of the option the right to buy the underlying security at a specified price, either on or before the expiration date
Call option
Intrinsic Value + Time Value =
Premium
Allows investors to profit from the movements of markets or market segments and hedge against these market swings
Options on indexes
Track the movement of market segments in a specific industry
narrow-based indexes
The VI or Volatility Index is also known as the ?
Fear gauge or index
Greater volatility general translates into ____ premiums for options contracts
Higher
- If the market is volatile that means there is additional risk for the writer of the contract.
Index Options typically use a multiplier of $____
$100
So, the premium amount is X by $100 to calculate the options cost, and the strike price is X $100 to determine the total dollar value of the index
The ____ of an index option settles in cash rather than in delivery of a security, and the cash must be delivered on the next business day (T+1)
Exercise
Defined as “The risk of a decline in the overall market”
Systematic or Systemic Risk
Options expire on the ____ Friday of the expiration month
3rd Friday
Consider EPIC when deciding on how to invest in currency options.
What does EPIC stand for?
Export = Put
Import = Call
So, if you are exporting as a business and are concerned about the value of a foreign currency dropping by a put
Vis-a-versus buy call
If the owner of an option may only issue exercise instructions on the last day of trading, this is an example of ____
European style options trading
An investor may make money in a strong bull market by
Buying Equity Index Calls
Remember that Index options are based off the strength of the market or a segment of a market
Buying a call means you believe market rates will go up.
So when you exercise a call. You are buying at a lower price than what is being sold on the open market.
Aka a discount
You’re an exporter who has become concerned recently that your customers home currency is about to decrease in value.
Meaning your payment may lose value
What options position should you take?
Buy puts.
Remember when buying a put you are betting on the market slowing down or losing value.
Ex: You buy an options contract with an exercise price of $45 per share
The market drops to $40 per share.
Your put creates an obligation for the writer (Seller) of the contract to buy the Share at $45 (Above market value)
Call sellers (Writers) are ____ investors. Why?
Bearish.
Remember, the most a seller makes is the premium
Because an investor will not exercise an option if it guarantees them a further loss.
So, a Short call investor (Sell call) is banking on the price of the asset falling.
So a buyer may have an exercise price of $45 if the price falls to $40, the buyer won’t exercise is option and lose $5.
So the seller keeps the premium - their profit
Strike Price + Premium = ____
For whom does this apply?
Break Even (BE) for a Call Buyer.
Strike Price - Premium = _____, and for whom?
BE or Break even, for a Put buyer
A Put Buyer is a _____ Investor
Bearish
Remember. A put buyer believes the market will fall in value.
So say his Exercise price is $45 and the asset falls to $35 in value.
The seller is obligated to by the asset at $35 meaning the Put buyer has made $10 per share
How might an investor hedge his position in a stock he believes will rise in value (bullish investor)?
What is this type of options trade called?
Go long put.
In order to break even however, the increase in stock value must be greater than the cost of the put purchase aka the premium
So, BE = Stock price + premium
Called = Protective Put
Protective calls hedge for an investor ____ a stock.
- betting on the price of a stock falling (Bearish investment).
By doing what?
Shorting
Buying a call option. Meaning if the price of the stock goes up they are ensuring they pay no more than the agreed upon exercise price of the stock.
Reducing the potential loss in their short position on a stock gaining value
Long Stock hedges with a ___ option
Put Option
To hedge against a short position, an investor might purchase a _______.
Call option
____ and ____ options for stocks are typically written in lots, with each lot representing 100 shares.
Put and Call options
True or False
If a written option expires out of the money - meaning that the stock price closes below the strike price, or above the strike price for a put option - the writer keeps the entire premium
True.
Remember in the case of selling a call. The writer is betting on the price of the underlying security dropping (Bearish)
In case of a put contract they are betting on the price of the underlying security to rising (bullish)
True or False
An options writer has the flexibility to close out their open contracts at any time.
True
- the writer removes their obligation by simply buying back their written options in the open market.
- due to time decay this often results in the writer buying the contract back for a lower price
Are similar to futures contracts because they’re agreements where; one party presents another party with the chance to buy/sell a security at an agreed upon future date.
Main difference*
The buyer has no obligation to follow through with the transaction if he or she chooses not to.
Ultimately the exchange is optional.
Options
Call option contracts are considered to have intrinsic value:
A. When CMV exceeds exercise price
B. When exercise price exceeds CMV?
C. One CMV is equal to exercise price
D. When the option holder has exercised the option?
A.
Call option contracts go ‘ in the money’ (intrinsic value) when the current market value of the underlying security exceeds the exercise price (strike price) of the option. If they call options, exercise price is $20, and the underlying stock is trading at $25, The intrinsic value of the call option is $5.
All of the below are typical features of an ETF except:
A. They are marginable
B. They’re often sector driven portfolios
C. They are traded each day based upon 4:00 p.m. NAV
D. None of the above are exceptions
C.
Exchange traded funds trade on exchanges at market prices determined by supply and demand - the same as regular corporate stocks.
Accumulation units are most often associated with:
A. Life insurance
B. Annuities
C. Mutual funds
D. ETFs
B.
Variable annuities sell accumulation units to purchasers, whose price each day is based upon the 4:00 p.m NAV of the separate account
One of the most frequently issued money market instruments is commercial paper. Typically, this investment has a maximum maturity:
A. Of 1 year
B. Of 90 days
C. Of 270 days
D. Of 180 days
C.
Maximum maturity is 9 months or 270 days
When an investor is bearish on the broad stock market:
A. Buying puts on the S&Pp 500 index is an appropriate strategy
B. Buying calls on the S&P 500 index is an appropriate strategy
C. Mutual funds is an appropriate strategy
D. Not investing in the market is an appropriate strategy
A.
Buying broad-based index put options will provide a hedge against the decline in the broad market.
Exercise of an equity put option involves the writer:
A. Selling the underlying instrument at the strike price
B. Buying the underlying instrument at the strike price
C. Selling the underlying instrument at the strike priceless premium
D. Buying the underlying instrument at the strike priceless premium
B.
When an investor shorts/writes (Sell) a put option, they agree to be obligated to buy the underlying instrument at the strike price
_________ is a financial contract between a buyer and a seller that gives the buyer the right, but not the obligation, to buy or sell an underlying asset (such as a stock, commodity, or currency) at an agreed-upon price (the “strike price”) within a specified time frame. The seller of the _____ is obligated to sell or buy the underlying asset if the buyer decides to exercise their option. _______ trading allows traders to speculate on the future price movement of an asset, to hedge against potential price changes, or to generate income through the collection of premiums.
Options Trading
Note
A put contract is a type of option contract that gives the holder the right, but not the obligation, to sell a specified underlying asset at a predetermined price (the “strike price”) before or on a specified expiration date. The holder of a put option is essentially betting that the price of the underlying asset will decrease. If the price does go down, the holder can sell the underlying asset at the higher strike price, effectively locking in a profit. If the price does not go down, the holder can choose not to exercise the option and let it expire worthless. On the other side of the trade, the seller of the put option is obligated to buy the underlying asset at the strike price if the holder decides to exercise their option, but they receive the option premium as compensation for taking on this obligation.
A call option is a type of option contract that gives the holder the right, but not the obligation, to buy a specified underlying asset at a predetermined price (the “strike price”) before or on a specified expiration date. The holder of a call option is essentially betting that the price of the underlying asset will increase. If the price does go up, the holder can buy the underlying asset at the lower strike price, effectively locking in a profit. If the price does not go up, the holder can choose not to exercise the option and let it expire worthless. On the other side of the trade, the seller of the call option is obligated to sell the underlying asset at the strike price if the holder decides to exercise their option, but they receive the option premium as compensation for taking on this obligation.
Note
_________ is the amount of interest that has accumulated on a debt security between coupon payments. It can be calculated as follows:
_________ = (Principal * Interest Rate * Number of Days Since Last Coupon Payment) / 365
Accrued Interest
