B.3 Insurance, Collars, and Other Strategies

Question 0

Position: Written Collar

Answer 0

1) Written put option

2) Purchased call option with higher strike price

Question 1

Position: Purchased Collar

Answer 1

1) Purchased put option

2) Written call option with a higher strike price

Question 2

Position: Bull Spread with put options

Answer 2

1) Purchased put option

2) Written put option with higher strike price

Question 3

Position: Bear Spread with call options

Answer 3

1) Written call option

2) Purchased call option with higher strike price

Question 4

Position: Bull Spread with call options

Answer 4

1) Purchased call option

2) Written call option with higher strike price

Question 5

To create a Bull Spread, the investor (writes/purchases) the option with the higher strike price.

Answer 5

The investor writes the option with the higher strike price in creating a Bull Spread. There are two possibilities:

1) Purchase a call option and write a call option with a higher strike
2) Purchase a put option and write a put option with a higher strike

Question 6

To create a Bear Spread, the investor (writes/purchases) the option with the higher strike price.

Answer 6

The investor purchases the option with the higher strike price in creating a Bear Spread. There are two possibilities:

1) Write a call option and purchase a call option with a higher strike
2) Write a put option and purchase a put option with a higher strike

Question 7

Buying a stock and writing a call option has the same payoff at expiration as (lending/borrowing) an amount equal to the present value of the strike price and writing a put option.

Answer 7

Lending.

Long stock + short call = bond PV(K) + long put
Own stock + write call = lend PV(K) + write put

Question 8

Profit(short stock + long call) is equivalent to ___________.

Answer 8

Profit(Long put)

Question 9

Out-of-the-money option

Answer 9

Option that if exercised immediately would have a negative payoff.

Question 10

At-the-money option

Answer 10

Option for which the strike price is approx. equal to the asset price.

Question 11

In-the-money option

Answer 11

Option that if exercised immediately would have a positive payoff (but not necessarily a positive profit)

Question 12

A call option is insurance for a ________ position.

Answer 12

Short; i.e. it hedges against the price risk of an asset you plan to own in the future.

Question 13

A put option is insurance for a ________ position.

Answer 13

Long; i.e. Insurance on an asset already owned.

Question 14

The profit on a long position in a stock and a put option is equivalent to that of a _________ option.

Answer 14

Purchased call option

Profit(long stock + long put) = Profit(long call)

Question 15

Give 2 differences between a synthetic forward and a normal forward.

Answer 15

1) Synthetic forward pays price K instead of forward price

2) Synthetic forward requires payment of net option premium

Question 16

In what scenarios (with respect to the underlying asset) are covered calls written?

Answer 16

When the price of the underlying asset is expected to stay the same.

*the profit on a covered call is equivalent to that of a written put

Question 17

Position: Long on asset and write a call option on that asset

Answer 17

Covered Call

Question 18

What is covered writing?

Answer 18

Writing an option when you have a corresponding long position in the underlying asset.

Question 19

Position: Short an asset, write a put option

Answer 19

Writing a covered put

Question 20

The profit on writing a covered call is equivalent to the profit on a __________ option.

Answer 20

Written put option.

Question 21

Profit(long stock + long put) = profit on _________ option.

Answer 21

Long call option.

Profit(long asset + written put option) = Profit(purchased call option)

Question 22

The profit on a covered put (short asset and write a put) is equivalent to the profit on a ___________ .

Answer 22

Written Call

Question 23

Payoff(long position + purchased put + borrow PV strike) is equivalent to the payoff on ________.

Answer 23

Purchased call option.

Question 24

Position: Own an asset, write a call option

Answer 24

Writing a covered call

Question 25

Covered calls have potential for ________ when the asset price increases, and the potential for ________ when the asset price decreases.

Answer 25

Limited profit when price increases | Large loss when price decreases

Question 26

Position: spread

Answer 26

Position with only calls or only puts

Question 27

How are bull spreads used?

Answer 27

A lower cost way to speculate that asset price will rise

Question 28

Position: Synthetic Long Forward

Answer 28

Purchase a call and write a put with the same strike price

Question 29

Position: synthetic short forward

Answer 29

Purchase a put option and write a call option with the same strike price

Question 30

A synthetic long forward with a strike price less than the forward price has a (positive/negative) net option premium.

Answer 30

Positive - you are locking in a price less than the forward price, so you must pay a premium equal to the cost of the call option minus the proceeds from selling the put option.

Question 31

A synthetic long forward with a strike price greater than the forward price has a (positive/negative) net option premium.

Answer 31

Negative; asset is purchased at a premium relative to forward price so a net payment is received equal to the proceeds from the put option - cost of call option.

Question 32

When the strike price is equal to the forward price the net option premium is _________

Answer 32

Zero. Cost of call option = Cost of put option

Question 33

Put Call Parity

Answer 33

The net cost of buying an asset using options must equal the net cost of buying an asset using forwards

Question 34

What is the cost of buying an asset using a forward at t = 0

Answer 34

PV(Fwd price)

Question 35

Cost of buying an asset using options at t = 0

Answer 35

[Call(K,T) - Put(K,T)] + PV(K)

Question 36

Put-Call parity in terms of the bargain element

Answer 36

PV(Fwd price - K) = Call(K,T) - Put(K,T)

Question 37

Box spread

Answer 37

Create synthetic long and short forwards at different prices; equivalent to buying a bull spread + buying a bear spread

Question 38

Ratio spread

Answer 38

Constructed by buying m calls at one strike price and selling n calls at a different strike price; exactly like a bull spread, but the number of calls isn't 1

Question 39

Position: Collared stock

Answer 39

Buy a stock, buy a put, and sell a call with a higher strike price * selling the call helps to pay for the purchase of the put * just like a bull spread with different instruments