Flashcards in 5 - BS continued Deck (23):
BS with dividend payment, what must be done before the BS formula can be applied?
PV of dividend must be subtracted from stock price at time zero
S0- D e^(-r x t)
why would an american option be exercised early?
high dividends and low time value
can american calls be valued using BS?
no not really, corresponding EU calls can be valued at every dividend date and maturity; and the highest of these values can give a lower bound to the value of a US option.
can american puts be valued using BS? what can be used to value a put in combination with BS?
no because exercise may be optimal on other dates outside of dividend dates, use put-call-parity
what does term structure of implied volatility mean?
the relationship between implied volatility and the time to expiration (straight line)
what does the volatility smile/skew refer to?
the relationship between implied volatility and exercise price (curved line)
What are the five greeks and what do they tell us?
delta - small changes in stock price
gamma - large changes in stock price
rho - interest
theta - time
vega - volatility
what figure from the BS formula give you the delta value? what is the range of this figure? what does the value tell us?
the hedge ratio
how does the delta/ N(d1) differ for a call or a put?
call delta is positive
put delta is negative
how does the call value react to delta? why?
when delta moves towards 1 call price increases, as the stock price has increased relative to X
when delta moves towards 0 call price decreases, as the stock price has decreased relative to X
at what value of delta is the call in/out of the money?
1 = in the money
0 = out of the money
when would you expect to see the greatest change in delta? when does it change less?
when the call is close to the money the change in delta is the greatest when stock price changes a little
when the call is far in/out of the money the delta does not change as much
what does a large gamma tell us? what does this mean for the delta and hedging?
that the call price is more sensitive to large stock movements. the delta is more sensitive and moves faster, means that it's difficult to hedge
when is gamma greatest? when does it change the most
both answers are; when option is at the money.
based on time, when does gamma increase the most?
closer to expiration
how does rho differ for call and put options?
call - positive
put - negative
when does the rho value move/change the most?
at the money
when vega increases, what happens to the price of calls? puts?
when does vega change the most? (have the greatest impact on option value)
when option is at the money
when is a large or small theta good/bad?
larger theta - more time is good for call and bad for put
small theta - less time is bad for call and good for put
when does theta change the option price most? when is time decay at its greatest?
when the option is at the money
what does delta hedging/ delta neutral entail?
holding shares and selling calls to maintain risk free position