Week 4 Flashcards
What is the setup of a binomial pricing model
Formula to calculate a sub period (delta t)
Formula to calculate a up/down state stock move
= Exp(stock vol*sqrt delta t)
Continously Compounded Interest Rate
formula
State price up formula
State price down formula
What is the put-call parity equation
When is it helpful?
This equation essentially states that the difference between the price of a call option and the price of a put option with the same strike price and expiration date is equal to the difference between the current stock price and the present value of the strike price.
Usually when it is asked “what must be the price”. you can use a no arbitrage argument.
what does the payoff of a covered call look like and when is it helpful
BXM provides long equity exposure (positive delta) and short volatility exposure (negative vega)
what does the payoff of a protective put look like and when is it helpful
PPUT provides long equity exposure (positive delta) and long volatility exposure (positive vega)
what does the payoff of a collar look like and when is it helpful
Its often used when you already own the stock. combo of covered call and a protective put. It has a floor and a cap on the price. youre protecting from vol moves, but u cant gain or lose much. You might have a very specific stock.
You own stock
You hedge against downside; so put
When ppl hedge by buying a put option, but with as little upfront capital as possible –> shorting call options. so you cheaply limited downside potential but at the cost of upside potential.
What is a bull spread
Bull spread occurs when traders use strike prices between the high and low prices at which traders want to trade a security = position gets better when stock price increases. Similar to a collor, but where a collar is a non directional move, a spread is directional. We are betting also on low vol move, but also to go up.
Bull with puts advantage; initial cash inflow
short 22 dollar strike, in order to make it a bull spread, it needed to be higher than the strike 18
right top purple; short call that we wrote with a lower strike price must be more valuable (faster itm), so the cost of the long puts is more than offset
What is a bear spread
While bear spread occurs when a trader sells a call option at a strike price, and then buys it at a higher strike price later, = position gets worse when stock price increases. Similar to a collor, but where a collar is a non directional move, a spread is directional. We are betting also on low vol move, but also to go up.
bear with calls advantage; initial cash inflow
Left top purple; short call that we wrote with a lower strike price must be more valuable (faster itm), so the cost of the long call is more than offset
What positions do you take in a straddle and strangle
