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Series 7 > Unit 4 > Flashcards

Unit 4 Flashcards

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Series 7 Top-off Exam flashcards
1
Q

In the Money

A

Keep in mind this is how much the option is above or below the strike price

INTRINSIC VALUE

It does not need to be covering the premium

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2
Q

Calls in money

A

When the market price is above the SP, Long or Short

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3
Q

Puts in money

A

When the the market price is below the SP, long or short

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4
Q

Option premium reflects two types of values

A

Intrinsic and Time

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5
Q

Intrinsic value

A

The amount by which the option is in the money

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6
Q

Time value

A

Market’s perceived worth of time remaining to expiration

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7
Q

Options Quotes

A

Quoted on a per share basis

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8
Q

Factors affecting premium

A

Volatility
Amount of intrinsic
time remaining until expiration
Interest rates

Greatest influence is volatility of underlying stock

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9
Q

Calculation of Premium

A

Intrinsic Value + Time Value

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10
Q

Reasons to buy calls

A

Speculation
Deferring a decision
diversifying holdings
protection of short position

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11
Q

Buy call speculation

A

Less investment

Investor can speculate on upward price by only paying premium

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12
Q

Buy call Decision deferr

A

Investor can buy a call on a stock and lock in purchase price until the option expires

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13
Q

Buy call diversify holdings

A

Cheap way to diversify portfolio

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14
Q

Buy call protect short stock

A

Option acts as insurance against rising price of stock

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15
Q

Buy call maximum gain

A

Unlimited

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16
Q

Buy call maximum loss

A

Premium paid

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17
Q

Reasons to sell call

A

Speculation
Increasing returns
Locking in sale price
Protection of long position

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18
Q

Sell call speculation

A

Additional income can be earned by keeping premiums

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19
Q

Sell call locking in sale price

A

If an investor has an unrealized profit in a stock and wants to sell, a written call can lock in the profit

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20
Q

Sell call protection of long position

A

limts downside to the extend of the premium received

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21
Q

Sell call maximum gain

A

Premium received

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22
Q

Sell call maximum loss

A

Unlimited

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23
Q

Exercise contract regular way (timing)

A

T+2

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24
Q

Closing transaction

A

If the investor sold, the option is closed by buying the option

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25
Q

How to hedge long stock position

A

Select a bearish option with either

LONG PUT OR SHORT CALL

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26
Q

How to hedge a short stock position

A

Select a bullish option with either:

SHORT PUT OR LONG CALL

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27
Q

“Best Buy”

A

Remember the best position is to buy an option

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28
Q

If question asks for partial protection, or how investor can IMPROVE rate of return…

A

Select short option position

generates premium income to improve rate of return

NOTE : RISK IS REDUCED BY PREMIUM RECEIVED

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29
Q

Covered call writing

A

Selling calls when holding a long stock position.

Partial protection that generates income and reduces potential upside

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30
Q

Protective Put

A

Long Stock, Long Put

Investor buys:
100 shares of RST at 53 and buys RST 50 put for 2

Maximum gain is unlimited (upside potential)
Downside is $500 (premium of 2 + 3 lost on long stock)
Breakeven $55/share ($53 + 2)

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31
Q

Covered Call

A

Long stock, short call

Investor buys:
100 shares of RST at 53 and writes 1 RST 55 call for 2

Maximum gain: $400 (owner of call will exercise at $57/share so $57-$53 = $4/share)
Maximum loss: $5,100 (if stock goes to 0, total cost was $5,300-$200 premium earned)
Break even = $51/share ($5,300 - $200)

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32
Q

Ratio call writing

A

Involves selling more calls than the long stock position covers.

Generates additional premium income

HAS UNLIMITED RISK WITH SHORE UNCOVERED CALLS

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33
Q

Short Stock Long Call

A

Investor :
SELLS 100 shares of RST at $58 and buys RST $60 call for 3

Maximum gain: $5,500 ($58 - $3 premium)
Maximum loss: $500 ($3 paid for premium + $2 on short)
Break even: $55/share

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34
Q

Short Stock, Short Put

A

Investor:
SELLS 100 at $55 and writes RST $55 put at $2.50

Maximum gain: $250
Maximum loss: Unlimited
Break even: $57.5/share

REMEMBER WHEN YOU WRITE YOU RECEIVED PREMIUM!!!!

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35
Q

Collar

A

Hedge downside risk on long position of stock for no out of pocket cash

Investor is long 100 shares of XYZ at 50

Buys a 45 put at 3
Sells a 44 call for 3

Cashless collar

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36
Q

Spreads

A

Simultaneous purchase of one option and sale of another option of SAME CLASS

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37
Q

Call Spread

A

long call and short call

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38
Q

Put Spread

A

long put and short put

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39
Q

Price spread (vertical spread)

A

One that has a different SP but same expiration date

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40
Q

Time spread (calendar spread)

A

includes option contracts with DIFFERENT EXPIRATION DATES.

Investors do not expect price volatility. Expect to profit from different rates.

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41
Q

Diagonal spread

A

Positions differ on both time and price.

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42
Q

Debit spread

A

If LONG option has higher premium than the short option

Long premium > Short premium

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43
Q

Credit spread

A

If SHORT option has higher premium that long option

Short premium > long premium

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44
Q

Debit call spread

A

Investors reduce the cost of long option position.

BULLISH POSITION

Buy 1 RST Nov 55 call for 6
Sell 1 Nov 60 call for 3

Max Gain = $200
Max Loss = $300
BE = $58

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45
Q

What type of spread would an investor look for premiums to widen?

A

Debit spread

When you begin to widen you need to exercise

Debit = Widen = Exercise

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46
Q

What type of spread would an investor look for premiums to narrow?

A

Credit spread

Credit spreads are profitable if premiums narrow and expiration occurs

credit = narrow = expire

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47
Q

CAL and PSH (finding break even points)

A

for Call Spreads; Add net premium to Lower SP

for Put Spreads: Subtract net premium from Higher SP

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48
Q

Maximum gain / loss calculation

A

T chart

IF result is net debit, net debit equals max loss

Max gain = subtract net debit from difference of two SP of spread

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49
Q

Credit Call Spread

A

Created to reduce the risk of short position.

Potential reward of the investor is reduced

BEARISH

Buy 1 RST Nov 55 call for 2
Sell 1 RST Nov 45 call for 9

Max gain = $700
Max loss = $300
BE = $52/share

50
Q

Debit Put Spread

A

Used to reduce cost of long put position

Bearish position

Buy 1 RST Nov 55 put of 6
Sell 1 RST Nov 50 put for 3

51
Q

Credit put spread

A

Created to reduce risk of short put position.

Potential reward for investor is reduced.

Bullish position.

52
Q

Max Gain - credit spred

A

Net credit

53
Q

Max loss - credit spred

A

Difference between strike price - net credit

54
Q

Max gain - debit spred

A

Difference between strike price - net debit

55
Q

Max loss - debit spread

A

Net debit

56
Q

Market attituede

A

determined by the option that is more costly of the two

57
Q

Call debit

A

if the investor PURCHASED the one with the lower SP (higher premium)

Bullish

58
Q

Call credit

A

If the investor SOLD the one with the lower SP (higher premium)

Bearish

59
Q

Put debit

A

Investor PURCHASED the one with the higher SP (higher premium)

Bearish

60
Q

Put credit

A

Investor SOLD the one with the higher SP (higher premium)

Bullish

61
Q

Market attitude trick

A

Buying Lower SP = Bull

62
Q

Straddle

A

Call and put with the same SP and expiration month

Can be long or short and are used by investors to speculate on price movement

INVESTOR PREDICTS HIGH VOLATILITY

63
Q

Long straddle

A

Expects substantial volatility but is uncertain where price will move.

Investor PURCHASES a call and put

64
Q

Short straddle

A

Expects price will not change or will change very little

collects two premiums by SELLING a call and put

65
Q

Max gain Long straddle

A

Unlimited

66
Q

Max loss Long Straddle

A

Total premium paid

67
Q

Breakevens Long straddle

A

Call: Strike price + both premiums
Put: Strike price - both premiums

68
Q

Maxgain Short straddle

A

Total premium received

69
Q

Max loss long straddle

A

Unlimited

70
Q

Break evens Short straddle

A

Call: Strike price + both premiums
Put: Strike price - both premiums

71
Q

Combinations

A

Includes call and put with different SPs, exirations months, or both.

Similar to straddles

72
Q

Use of a combination

A

Cheaper to establish than long straddles if both options are out of money

73
Q

Long straddle example

A

Long Jan 40 call and Long Jan 45 put

In money when underlying stock is OUTSIDE breakeven points

74
Q

Short straddle

A

If investor writes both option - result is short combo

Makes money when underlying stock stays BETWEEN Breakeven points

75
Q

Non-equity options

A

function the same as equity options except:

Different contract sizes
Different delivery and exercise standards

76
Q

Options indexes

A

allow investors to profit from movements in markets or segments

also can hedge against market swings

77
Q

Broad based indexes

A

reflect movement of entire market

78
Q

Narrow based indexes

A

track movement of market segments in a specific industry which as tech or pharmaceuticals

79
Q

Index option multiplier

A

Typically use a $100 multiplier

80
Q

Index option trading

A

T+1

81
Q

Index option exercise

A

Settles in cash rather than delivery of security. Settles next day.

82
Q

Index option settlement price

A

Based on closing value of index on day of exercise.

Not value at time of exercise.

83
Q

Index option expiration dates

A

Expire on third Friday of expiration month

84
Q

Index option time value

A

Premium - Intrinsic

85
Q

Index option strategy

A

If investor is bullish: buy calls or write puts

If investor is bearish: write calls or buy put

86
Q

Portfolio insurance

A

portfolio manager guys a put on index to offset if market value decreases

87
Q

Beta

A

measure of volatility of stock or portfolio related to the volatility of the market in general.

88
Q

Beta of 1.0

A

same volatility as market in general

89
Q

Beta of 1.2

A

20% more volatile than market in general

90
Q

Interest rate options

A

Yield based off T-bills, notes, and bonds.

If investor is bullish and buys yield based option with SP of 35 (reflects a yield of 3.5%). If rates rose to 4.5% investor could exercise and receive CASH equal to intrinsic value

Can buy/sell puts and calls

91
Q

Foreign currency options

A

allows investors to speculate on the performance of currencies other than USD

Provides protection against fluctuating currencies

92
Q

Foreign currency settlement

A

Next day in USD

93
Q

Foreign currency contract sizes

A

$10,000

$1,000,000 YEN

94
Q

Foreign currency strike prices

A

Usually quoted in US cents

Yen is 1/100th of a cent

95
Q

Foreign currency premiums

A

Quoted at cents per unit

96
Q

FX premium example

A

Contract of 10,000 units is quoted with a premium of 1.5, cost of contract equals

10,000 x 0.15 or $150.

97
Q

FX option expiration date

A

3rd friday of month

98
Q

Understanding FX prices

A

If USD is rising - other currencies are falling

If USD is falling - other currencies are rising

99
Q

If importer believes USD will fall against Swiss franc then…

A

Investor should buy calls on franc to lock in purchase price

100
Q

Who buys FX calls who buys FX puts

A

Importers buy calls
Exporters buy puts

Rule of thumb - exporters buy puts on the foriegn currency

101
Q

KEEP IN MIND NO OPTIONS CAN BE BOUGHT ON USD

A

So if British exporter is looking to hedge risk - he would buy BP call (no USD)

102
Q

Listed options

A

Exchange traded options

Standardized strike price, expiration date etc

103
Q

Listed options settlment

A

regular way (t+2)

104
Q

Automatic exercise

A

if in money at least by 0.1, they are automaticall exercised

105
Q

Options position limits

A

No more than 250,000 contracts on same side may be exercised within 5 BD

Apply to individuals , registered resp acting in discretion, and individuals acting in concert

106
Q

Options exercise limits

A

OCC time limits for max number of contracts (on same side of market) is 5 BD

107
Q

American / European contracts

A 
American = can exercise option at any time
European = only can exercise at expiration date
108
Q

Where are options traded?

A

CBOE - Chicago board of options exchange

109
Q

Designated Primary Market Maker

A

Floor trader responsible for maintaining two sided market for product on CBOE.

Can perform roles of market maker and/or floor broker

110
Q

Options market maker

A

Registered with the exchange to trade for their own accounts. Must stand by and be ready to buy and sell.

111
Q

Order routing systems

A

Computerized system used to route customer orders directly to the trading post.

112
Q

Options Clearing Corporation (OCC)

A

Clearing agent for options contracts

Determines when new options should be offered

Designates SP and expiration month

113
Q

Exercise of option through OCC

A

Guaranteed by OCC

BD notifies OCC, then OCC assignes exerciese notices on random basis.

BD then assign exercise notice on random basis based upon FIFO or any other type of reasonable method

114
Q

OCC Options Disclosure Document

A

Must be provided at or before account approval.

No later than 15 days after approval, customer must return options agreement.

115
Q

Options Contract Adjustments

A

Adjusted for splits, reverse splits, dividends and rights offerings

NOT ADJUSTED FOR

Ordinary cash dividends or distributions

116
Q

Stock splits - option contracts

A

When occur:

Additonal options contracts are created.

After a 2:1 split 1 ALF 60 call becomes 2 ALF 30 call

117
Q

Uneven split - options contract

A

Adjusted for uneven splits

After a 3:2 split

1 ALF 60 call will be represented by 1 ALF 40 call

118
Q

Closing transaction

A

can be buy or sell

BD needs to disclose if it is a covered or uncovered transaction

119
Q

Put - Call ratio

A

Reflects the current open interest in trade of put options to call options

Divide number of traded put options to number of traded call options

Higher ratio - more bearish investors have been

Note: can be contrarian, long high ratio could mean that its time to start buying

120
Q

Exercise Long Call

A

closing purchase

121
Q

Exercise Short call

A

closing sale

122
Q

Married put

A

If on same day customer buys stock and buys put option, the option is MARRIED to stock

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