Week 9 - Put & call options Flashcards
1
Q
Call option
Put option
European put/call option
American put/call option
A
Call option
- gives the owner the right, but not the obligation to BUY the underlying asset @ a specified strike price K, at a specified maturity date T
Put option
- same thing except the right to SELL
2
Q
Long position in a call
Short position in a call
Long put option
Short put option
^different ways to express. Show the shape of the payoff diagrams
A
See notes
3
Q
4 option strategies & when investors use them
A
- Straddle
- when investor believes that the stock is VOLATILE (will move significantly) but have no particular opinion of which direction the stock price will move
- investor can get payoff regardless of where ST moves
- for speculation - Reverse straddle
- when investor believes that the stock has LITTLE VOLATILITY & believes that ST will be close to EXERCISE PRICE K
- for reverse speculation - Bull spread using calls
- if investor has a MILDLY BULLISH VIEW but who wants a portfolio that is protected against extreme price moves - Bear spread using puts
- if investor has a MILDLY BEARISH VIEW about the underlying but wants a position that is not too sensitive to extreme market movements
4
Q
Put-call parity & explain the strategies
Put-call parity with dividends formula
A
C0 + PV(K) = S0 + P0
C0 + K/(1+rrf)^T = S0 + P0
- Buy stock today and buy put
- Buy call and invest PV(K) at risk-free rate (ie. invest in a risk-free bond)
C0 + PV(K) + PV(DIVS) = S0 + P0