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RSM336 Investments > Week 5 - Options > Flashcards

Week 5 - Options Flashcards

1
Q

What are in-the-money options?

A

Exercise of the option would be profitable.

  • Call: market price > exercise price
  • Put: market price < exercise price
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2
Q

What are out-of-the-money options?

A

Exercise would not be profitable

  • call: market price < exercise price
  • put: exercise price < market price
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3
Q

What are some of the different types of options?

A
  • Stock options
  • Index options
  • Futures options
  • foreign currency options
  • interest rate options
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4
Q

What is the difference between American and European Put options?

A
  • American: the option can be exercised at any time before expiration or maturity
  • European: can only be exercised on the expiration or maturity date
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5
Q

What are exotic options?

A
  • asian options; strike price is floating
  • Russian options; don’t have an explicit expiration. Exercise has loopback provision, owner can pick any time between 0 and T
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6
Q

What is the payoff profile of a call holder?

A

St - X if St>X
0 if St

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7
Q

What is the payoff profile of a call writer?

A

-(St - X) if St>X
0 if St

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8
Q

What is the payoff profile of a long put?

A

0 if St > X
(X-St) if St < X

Profit = Payoff - Premium

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9
Q

What is the payoff profile of a short put?

A

0 if St>X
-(X-St) if St

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10
Q

What is the put-call parity?

A
  • Payoff of long call/short put has a risk free profile in terms of payoff; always get the same payoff –> same payoff as borrowing X/(1+rf)^t, and buy 1 share of stock
  • call option + owning something (bong that is worth $50 at expiration)
  • bond + call; bowl $50 call is worthless but you have the bond
  • consider the strategy of buying a call option and, in addition, buying treasury bulls with face value equal to the exercise of the call

C + (X/(1+rf)^t) = S0 + P
P = C - S0 + PV(X) + PV(Dividends)

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11
Q

What is there is disequilibrium?

A

acquire the low-cost alternative, sell the high-cost

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12
Q

What is a naked call?

A
  • A naked call is an options strategy in which an investor writes (sells) call options on the open market without owning the underlying security.

buying index calls to participate in market advances
- P&L characteristics: profit potential will be theoretically unlimited. The loss potential is limited to the premium paid for the call.

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13
Q

Naked put?

A
  • A naked put is an options strategy in which the investor writes, or sells, put options without holding a short position in the underlying security.

buying index puts in anticipation of a market correction.
- P&L characteristics: the maximum loss on a purchased index would be limited to the premium paid for the option. This strategy does present the investor with the potential for large but limited gains, should their forecast of market correction be corrected.

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14
Q

Covered Call

A
  • purchase of a share of sock with a simultaneous sale of a call option on that stock
  • most often employed when the investor, while bullish on the underlying stock, feels that its market value will experience little range over the lifetime of the call contract
  • the investor desires to either generate additional income from share of the underlying stock, and/or provide a limited amount of protection against a decline in underlying stock value
  • covered call regarded as a conservative strategy because it decreases risk of stock ownership
  • short-term bearish

- long-term bullish

- premiums collected softens the loss on stock price asset decrease

Payoff:

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15
Q

Protective Put

A
  • investing in a stock a purchasing a put - unwilling to bear potential loss beyond some given level
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16
Q

What is the payoff of a protective put?

A
17
Q

What is the payoff of a covered call?

A
18
Q

What is a straddle?

A
  • long straddle: buy a call and put w/ the same exercise price and maturity –> to make a profit, he change in the stock price must exceed the cost of both options
  • the inverse is writing straddles, selling a call and a put - must believe the stock price is less volatile
19
Q

What are spreads?

A
  • a spread is a combination of wo or more calls (or puts) on the same stock with: different exercise prices, or times to maturity
20
Q

What is a bull-call spread?

A
  • a bullish spread is an optimistic strategy designed to profit from a moderate rise in the price of a security or asset; achieve maximum profit if the underlying asset closes at or above the higher strike price
  • a bull-call spread is a vertical spread consisting of buying the lower strike price call and selling the higher strike price call, both expiring at the same time

–> the primary purpose of the short call is to help pay for the long calls upfront cost

  • one motivation for the bullish spread is that the investor thinks one option is overprice relative to another
21
Q

What is a bear call spread?

A
  • this strategy is generally used to generate premium income based on an options trader’s bearish view of a stock, index etc.
  • modest downside is expected
  • a bear call spread is a vertical spread strategy where the investor sells a lower price call option and buys a higher price call option
22
Q

What is a butterly call spread?

A
  • a long butterfly spread consists of three legs; buying one call with a strike price of A, selling two calls with a strike price of B, and buying a call with a strike price of C
  • ideally you want the calls with strikes B and C to expire worthless whil capturing the intrinsic value of the in-the-money call with strike A
  • because you’re selling two options with strike B, butterflies are relatively low cost
23
Q

What is the risk reversal option strategy?

A
  • this strategy protects against unfavorable price movements in the underlying position but limts the profits that can be made on that position
  • consists of buying and out-of-the-money call call options and selling an out-of-the-money put option in the same expiration month
  • if you are bullish about a stock, you can use this strategy instead of going long the stock. Cheaper because the money from the sale of the put option partially pays for the purchase of the call
  • it can protect an investor who is short the underlying asset from a rising stock price
24
Q

What is a strip and a strap?

A
  • a strip is two puts and one call
  • a strap is two calls and one put
25
Q

Main parts of option pricing

A
  • an option’s price is made up of two main parts: its intrinsic value and its time value
26
Q

What is Intrinsic Value?

A
  • the value any given option would have if it were exercised today
  • (St-X)
  • options trading at the money or out of the money have no intrinsic value
27
Q

What is Time Value?

A
  • the difference between the option price and the intrinsic value
  • since options have a finite amount of time before they expire, the amount of time remaining has a monetary value
  • it is directly related to how much time until the option expires, as well as the volatility in the stock’s price

0 the more time an option has until it expires, the greater change it’ll end up in the money. The time value of an option decays exponentially

28
Q

What factors affect option values?

A
  • Stock price, increases
  • exercise price, decreases
  • volatility of stock, increases
  • time to expiration, increases
  • interest rate, increases
  • dividend rate, decreases
29
Q

What is black-scholes?

A
  • Black-scholes is a pricing model used to determine the fair price of theoretical value for a call or put option based on six variables such as volatility, type of option, underlying stock price, time, strike price, and risk-free rate

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RSM336 Investments (9 decks)

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