Options Flashcards
3 Reasons to invest in options
Hedging
Speculation
Income
Intrinsic Value of Call Option formula
Stock price - Strike price
Intrinsic value can NOT be less than 0
Intrinsic Value of Put Option
Strike Price - Stock Price
Time Value of an Option formula
Time Value =
Premium - Intrinsic Value
How to add Portfolio Insurance with Puts?
Using Put option on an index to “lock-in” portfolio gains
Typically when you have diversified portfolio and worried about market downturn
Buying puts on S&P500 will protect a well diverted portfolio
Long Straddles
Buy a Put and a Call
Expect volatility but not sure which direction
Short Straddle
You Sell a Put and Call
You don’t expect volatility, just hoping to keep the premiums
Black Scholes does what?
Determines value of a call option
Black Scholes uses what Variables?
Current price of stock
Time to expiration
Risk-Free rate
Volatility of stock
(All of above increase the value of call option as they get higher)
Strike Price
(Inversely related to value of option)
Put/Call Parity
To value a Put based on value of a Call
Binomial Pricing Model
Values an option based on assumption that stock can only move in one of two directions
Tree structure
Warrants
Essentially Call options issued by a corporation
Expiration is much longer than options, usually 5-10yrs (options are 9 months or less)
Warrant terms are NOT standardized
Used as sweeteners to a bond deal
Naked Call
Sell a call option on a stock I don’t own
Max Loss is Unlimited
Futures
Commodities (copper, wheat, oil, corn, pork)
Financial (currency, interest rates, stock indexes)
Obligate holder to make or take delivery of underlying asset
Process of Hedging a position with Futures
Long the commodity, Short the contract:
Orange grove owner knows the price he must receive to make profit, the future Orange price is unknown, but current price on contract for future delivery is known. You sell a contract for future delivery to lock in your sale price.
