Unit 4:: Nonequity Options

Question 1

Non equity options

Answer 1

contracts on instruments other than common stock. Most well known options are yield-based options, index options, and foreign currency options (FCOs)

Question 2

Yield Based Options

Answer 2

Trade on CBOE; Available on most recently issued Treasury debt securities

• 13-week Treasury Bills
• 5 and 10 year Treasury Notes
• 30 Year Treasury Bonds

Hedge against interest rate risk
Contract size multiplier of $100
Settlement is next business day in cash (rather than delivery of security)

Strike price is underlying security’s annualized YTM

Question 3

Yield Based Options - American or European?

Answer 3

European style (exercised on trading day before expiration)

Question 4

Exercise Settlement Value

Answer 4

Current yield on the underlying security multiplied by 10

Question 5

Price of debt securities have an inverse relationship to interest rates but their yields…

Answer 5

have a direct relationship. When interest rates rise, yields rise. An investor who thinks interest rates will increase might buy calls on yields of debt securities

Question 6

Index

Answer 6

a statistical measure of the changes in a portfolio of stocks representing a portion of the overal market

Question 7

Selection Risk

Answer 7

relates to the specific company in which the investment is being made. AKA company risk or nonsystematic risk

Question 8

Market Risk

Answer 8

market volatility risk

Question 9

Broad-Based (Market) Indices

Answer 9

Tracks the composite price performance of a large number of individual stocks (ex: S&P 500 Index)

Trade from 9;30-4:15 and have no position or exercise limits

Question 10

Narrow Based (Industry) Indices

Answer 10

Reflects a composite price on a group of stocks, all within a specific industry or market sector (ex: gold/silver and computer tech)

Typically trade from 9:30-4:00

Question 11

Commodity Exchange Act

Answer 11

Defines a narrow based security index as having nine or few components; Broad based as having more than nine components

Question 12

Index option

Answer 12

Current index price by multiplier of 100

Question 13

Index option - strike price

Answer 13

Have five-point strike price intervals bracketing the current index value. Additional strike prices are opened as index reaches new strike level

The minimum price variation (tick) on an index option quote is $.05

Question 14

Index option - settlement

Answer 14

in cash, next business day

Question 15

Index option - expiration

Answer 15

Saturday following the 3rd Friday of the expiration month (same as equity options)

No position limits

Question 16

Index options - exercise

Answer 16

In the money call - profitable when index price is higher than strike price
In the money put - profitable when index price lower than strike price

Price risk - because of fast market and are settled as cash next business day (cash value not determined until end of market day). So most investors liquidate as closing transactions Most do not exercise, only close option because of time value.

Question 17

Position/Exercise limits

Answer 17

Broad-based index options - no position or exercise limits

Narrow-based index options - set by OCC

Question 18

VIX options (Volatility Index options)

Answer 18

broad-based, European style contracts. Value is derived from the S&P 500 index option. Designed to reflect investors’ view of expected stock market volatility over next 30 days

Question 19

VIX options - expiration

Answer 19

Settle in cash next business day; Expiration is Wednesday that is 30 days prior to the 3rd Friday of the calendar month immediately following the expiration month.

Question 20

Flex Options

Answer 20

Offers investors the opportunity to create customized equity or index options designed to accomplish particular strategies and goals. Investors can specify expiration date, strike price, and exercise style (American or European)

Question 21

Flex Options

Answer 21

• expiration can be set on any business day up to 5 years from issuance with following exception: exp cannot be on or within 2 business days of a non FLEX expiration date.
• minimum of 250 contracts
• position limit of 200,000 contracts on same side of market

Question 22

Beta

Answer 22

used to measure the volatility of one stock or a portfolio of stocks against the volatility of the stock market as a whole.

Question 23

Capped index call option

Answer 23

most similar to a debit call spread

Question 24

Foreign Currency Options (FCO’s)

Answer 24

Used to speculate on the movements of the underlying currency but to hedge risks encountered when transacting and settling foreign trade accounts

Also used to hedge risks that corporations face when doing business abroad

Question 25

Spot market

Answer 25

Refers to the price a commodity commands if it is bought or sold for 1 or 2 day delivery or ownership transfer

The spot market closing price determines whether option is in the money, at the money, or out of the money

Calls for physical delivery of the currency sold one or two vusiness days after transaction date

Question 26

FCO’s - value date

Answer 26

aka delivery date

Question 27

Forward market

Answer 27

can be negotiated for delivery at a later date. ex: 1, 3, 6, 9, 12 months

Question 28

FCO - expiration and exercise style

Answer 28

Saturday following the 3rd Friday of the expiration month; European style

Question 29

EPIC

Answer 29

Exporters buy puts, Importers buy Calls