Unit 4:: Nonequity Options Flashcards
Non equity options
contracts on instruments other than common stock. Most well known options are yield-based options, index options, and foreign currency options (FCOs)
Yield Based Options
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
Yield Based Options - American or European?
European style (exercised on trading day before expiration)
Exercise Settlement Value
Current yield on the underlying security multiplied by 10
Price of debt securities have an inverse relationship to interest rates but their yields…
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
Index
a statistical measure of the changes in a portfolio of stocks representing a portion of the overal market
Selection Risk
relates to the specific company in which the investment is being made. AKA company risk or nonsystematic risk
Market Risk
market volatility risk
Broad-Based (Market) Indices
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
Narrow Based (Industry) Indices
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
Commodity Exchange Act
Defines a narrow based security index as having nine or few components; Broad based as having more than nine components
Index option
Current index price by multiplier of 100
Index option - strike price
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
Index option - settlement
in cash, next business day
Index option - expiration
Saturday following the 3rd Friday of the expiration month (same as equity options)
No position limits
Index options - exercise
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.
Position/Exercise limits
Broad-based index options - no position or exercise limits
Narrow-based index options - set by OCC
VIX options (Volatility Index options)
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
VIX options - expiration
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.
Flex Options
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)
Flex Options
- 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
Beta
used to measure the volatility of one stock or a portfolio of stocks against the volatility of the stock market as a whole.
Capped index call option
most similar to a debit call spread
Foreign Currency Options (FCO’s)
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
Spot market
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
FCO’s - value date
aka delivery date
Forward market
can be negotiated for delivery at a later date. ex: 1, 3, 6, 9, 12 months
FCO - expiration and exercise style
Saturday following the 3rd Friday of the expiration month; European style
EPIC
Exporters buy puts, Importers buy Calls
