FMP12 - Options Markets

Question 1

Describe the various types and uses of options; define moneyness

Answer 1

European call (or put) gives the buyer the right to buy (or sell) an asset at a specified price an EXACT time, American is ANY time before maturity.

• in-the-money: positive payoff
• at-the-money: zero payoff
• out-of-the-money: negative payoff

Question 2

Explain the payoff function and calculate the profit ad loss from an options position

Answer 2

Long call profit function = max(S - K, 0)
Short call = min(K - S, 0)
Long put = max(K - S, 0)
Short put = min(S - K, 0)

Question 3

Explain the specification of exchange-traded stock option contracts, including that of non-standard products

Answer 3

Contract defines maturity and strike price on the underlying asset

Non-standard products define certain variations and the bounds of them

Question 4

Explain how dividends and stock splits can impact the terms of a stock option

Answer 4

Cash dividends do not affect stock options unless over 10%. Stock splits and stock dividends reduce strike proportionally

Question 5

Describe the application of commissions, margin requirements, and exercise procedures to exchange-traded options and explain the trading characteristics of these options

Answer 5

Options with maturities longer than 9 months can be bought on margin, but no more than 25% can be borrowed

Question 6

Define and describe warrants, convertible bonds, and employee stock options

Answer 6

-Warrants are options issued by a corporation to buy the corporations own stock

• Convertible bonds can be converted into equity using a pre-determined exchange ratio