Unit 3: Derivatives Flashcards
Derivative
contract that derives its value from an underlying asset
Long call
> right to buy 100 shares of a stock at the strike price before expiration of the contract
call buyer is bullish (hope CMV of shares will rise so they can buy them low)
Short call
> obligation to sell 100 shares of a stock at the strike price when contract is exercised
call seller is bearish (hope CMV of shares will fall so they sell them high)
Long put
> right to sell 100 shares of a stock at the strike price before expiration of contract
put buyer is bearish (hope CMV of shares will fall so they sell them high)
Short put
> obligation to buy 100 shares of a stock at the strike price when contract is exercised
put seller is bullish (hope CMV of shares will rise so they buy them low)
In the money call
> CMV of stock exceeds strike price
>call will be exercised by buyer, they can buy low
Out of the money call
> CMV of stock is lower than strike price
call will not be exercised by buyer
seller will keep premium
Intrinsic value
> the amount a contract is in the money
>always positive or zero
Parity
when premium of option equals intrinsic value
In the money put
> CMV of stock is lower than strike price
>call will be exercised by buyer, they can sell high
Out of the money put
> CMV of stock is higher than strike price
buyer will not exercise option
seller keeps premium
Premium formula
intrinsic value + time value
Option
contract between buyer and seller in which the buyer has right to buy or sell underlying assets and the seller is obligated to fulfill the contract if exercised
Equity option
option contract with stock as underlying asset
Nonequity option
option contract with underlying asset other than stock
Index option
> option contract with index fund as underlying asset
use multiplier of $100
settle T+1 in cash
Long call breakeven point
strike price + premium
Long call maximum gain
unlimited, because CMV of stock could rise to infinity above strike price
Long call maximum loss
premium (if long call is out of the money buyer will not exercise)
Short call breakeven point
strike price + premium (if contract is exercised seller would need to buy stock and lose premium at min.)
Short call maximum gain
premium (only $ possible for seller to make)
Short call maximum loss
> unlimited, because CMV could rise to infinity over strike price
seller would need to buy shares off market before selling them to buyer at strike price
Long put breakeven point
strike price - premium
Long put maximum gain
strike price - premium (same as breakeven because strike price will never change)
Long put maximum loss
premium (because long put is in the traditional seller’s position)
Short put breakeven point
strike price - premium
Short put maximum gain
premium (only $ possible for seller to make)
Short put maximum loss
strike price - premium (same as breakeven because strike price will never change)
Protective put
> Long stock, long put
>bullish investor can lock in min. sell price if CMV of shares drop
Protective call
> Short stock, buy call
>bearish investor can lock in low buy price if CMV of shares increases
Covered put
Writer of option already has cash available to purchase shares from buyer if they exercise contract
Uncovered put
> Writer of option does not have cash available to purchase shares from buyer if they exercise contract
Needs to find cash from elsewhere
Covered call
Writer of option already owns shares to be delivered to buyer if they exercise contract
Uncovered call
> Writer of option does not own shares to be delivered to buyer if they exercise contract
Will need to buy shares at high CMV to sell to buyer
Unlimited risk, CMV could be infinity
Options trading account set-up process
1) rep. determines options are suitable for investor
2) rep. shares Options Disclosure Document w/ investor
3) account is approved for options trading by registered options official
4) options trades entered
5) signed options agreement must be returned within 15 days of account approval
