Week 4 Flashcards
Assets Underlying Options
Future options
What happens when a call option is exercised?
the holder acquires a long position in the underlying futures contract plus a cash amount equal to the excess of the futures price over the strike price
out-of-the-money options
- A call option is out-of-the-money if the strike price is greater than the asset price.
- A put option is out-of-the-money if the strike price is less than the asset price.
Calendar Spread Using Calls use
•options that have the same strike price, but different expiration dates.
Option Bounds
An American or European call option gives the holder
the right to buy one share of a stock for a certain price. No matter what happens, the option can never be worth more than the stock.
Combinations - A Strangle Combination
Features
–The call strike price is higher than the put strike price.
-Again, as with a Straddle, the investor is betting that there will be a large movement in the stock price, but is uncertain as to the direction
–writing a covered call option
•selling a call option (a short position) and simultaneously buying the underlying stock.
AKA synthetic short put
Combinations - Strip & Strap
Describe a strap
•A Strap consists of a long position in two call options and a long position in one put option with the same strike price and expiration date.
–In a Strap the investor is betting that there will be a large stock price move and considers an increase in the stock price to be more likely.
–protective put.
draw diagram
advantages of bull spread strategy
•limits both the investor’s upside as well as downside risk but they hope that the stock price will increase, to provide them with a positive payoff.
describe the reverse of a covered call
buying a call option (a long position) and simultaneously selling the underlying stock.
•used when expecting the stock price to drop.
known as a synthetic long put
A Bull Spread using calls is created by
buying a call option on a stock with a certain strike price and selling a call option on the same stock with a higher strike price
when is a butterfly sprad appropriate strategy?
Why?
large stock price movements are unlikely
because a Butterfly Spread leads to a profit if the stock price does not move by much, and gives rise to a small loss if there is a significant movement in the stock price in either direction
A Bull Spread Using Calls
draw
Option Bounds
An American or European put option gives the holder the right
what happens if it were higher?
the right to sell one share of a stock for the exercise price. No matter how low the stock price becomes, the option can never be worth more than X.
Features of Bull Spread Using Calls
–Both options have the same expiration date.
–Because a call option price always decreases as the strike price increases, the value of the option sold is always less than the value of the option bought therefore requiring an initial investment.
Assets Underlying Options
Future options
What happens when a put option is exercised?
–When a put option is exercised, the holder acquires a short position in the underlying futures contract plus a cash amount equal to the excess of the strike price over the futures price.
Combinations - A Strangle Combination
Define
•In a Strangle, an investor buys a put and a call option with the same expiration date and different strike prices.
the reverse of a protective put
- selling a put option and simultaneously selling the underlying stock.
- It is known as a synthetic short call and is used when expecting the stock price to drop.
Assets Underlying Options
Future options
When do future options mature?
–A futures option normally matures just before the delivery period in the futures contract.
Usually there is some chance that an American option will be exercised early
what is the exception? Why?
American call on a non-dividend paying stock. These options should never be exercised early:
–No income is sacrificed;
–We delay paying the strike price; and,
–Holding the call provides insurance against the stock price falling below strike price.
Combinations - Strip & Strap
diagram
A Butterfly Spread requires a
small initial outlay.
Calendar Spread Using Puts
diagram
Option strategies which can be divided into three main categories
- Taking a position in an option and the underlying asset;
- A spread which involved taking a position in two or more options of the same type; and,
- A combination which involved taking a position in a mixture of call and put options.
calendar spread using calls
a loss is incurred when
•the stock price is significantly above or below the strike price.
A Bull Spread using puts
advantages
•provides a positive cash flow to the investor up front.
Calendar Spread Using Calls
diagram
–writing a covered call option
when is it used and why?
used when expecting the stock price to rise
- long stock position on the stock covers or protects the investor from the payoff on the short call that becomes necessary if there is a sharp rise in the stock price
A Bear Spread using call options
Advantages
–As with Bull Spreads, the spread limits both the investor’s upside profit potential and downside risk.
.
A Bear Spread using call options
What does the investor hope?
•The investor is hoping that the price of the stock will decrease to give them a positive payoff
Butterfly Spread Using Calls
diagram
Combinations - A Strangle Combination
Diagram
A Calendar Spread using calls can be created by
–selling a call with a certain strike price and buying a longer maturity call option with the same strike price.
calendar spread using calls
The investor makes a profit if
the stock price at the expiration of the short maturity option is close to the strike price of the short maturity option.
•The lower bound for the price of a European put option on a non-dividend paying stock is:
Bear Spread Using Calls
diagram
A Straddle Combination
diagram
–reverse of a covered call diagram
Butterfly Spread Using Puts diagram
•American Vs. European Options:
American options can be exercised any time before the maturity date, hence are worth more than European options
Option Bounds
An American or European call option gives the holder the right to buy one share for a certain stock price, no matter what happens, the option can never be more than the stock price, show
what happens if it were higher?
•hold an arbitrageur could easily make a riskless profit by buying the stock and selling the call option.
A Bear Spread using call options can be created by
•buying a call option with a high strike price and selling a call with a low strike price, leading to an initial cash inflow.
bull spread using puts
The Impact of Dividends on Lower Bounds to Option Prices
writing a covered call option diagram
the reverse of a protective put
diagram
option bounds
For European options, we know that at maturity the option cannot be
For European options, we know that at maturity the option cannot be worth more than X. It follows that it cannot be worth more than the present value of X today, as it cannot be exercised early
feature of calendar spread using calls
–The longer the maturity of an option, usually the more expensive it is.
-Therefore a Calendar Spread using calls generally requires an initial outlay.
Bear Spreads using puts
