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Ser 7 > Ch 9 - Options > Flashcards

Ch 9 - Options Flashcards

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1
Q

Options exp

A

9m after issue ,
typically expire on the third Friday of the expiration month at 11:59pm ET**.
some longer-term does exist

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2
Q

CBOE (Chicago Board Options Exchange)

A

Options primarily trade in Chicago on the CBOE (Chicago Board Options Exchange). Chicago is in the Central time zone, which is one hour behind Eastern. When you encounter test questions on expiration, be careful and watch for time zones!

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3
Q

Weekly options

A

exp one week

Issued on a Thursday and expiring the following Friday,

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4
Q

LEAPS (long-term equity anticipation securities)

A

long-term options that last up to three years (39 months)

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5
Q

derivative securitie

A

investments that obtain (derive) value from price changes in an underlying asset

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6
Q

Equity (stock) options

A

buying a contract that gives them a specific right
Known as a holder

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7
Q

Index options

A
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8
Q

Long options

A

option purchasers are “long” options and are known as holders. Holders pay premiums (creating a debit) to gain the right to transact at a fixed price before expiration and hope to exercise the option if it goes “in the money” (gains intrinsic value).

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9
Q

Intrinsic value

A

is the profit the holder makes when an option is exercised.

without intrinsic value = “out of the money” (OTM).

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10
Q

Short options

A

option sellers are “short” options and are known as writers. Writers receive premiums (creating a credit) in return for obligating themselves to perform a transaction at a fixed price. Option sellers hope their options remain “out of the money” (without intrinsic value) and expire worthless.

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11
Q

Options are used for

A

Speculation
Protection
Income

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12
Q

the Options Clearing Corporation (OCC).

A

only one issuer with options
The OCC is responsible for issuing options, standardizing contracts, and guaranteeing performance.

Each option contract is standardized, which allows for easy trading

clearinghouse (sometimes called a clearing agent) for the options markets. ensure options transactions execute properly after a trade is made.

OCC issues, then trades on CBOE, and premium depends on S&D

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13
Q

option settlement day

A

the trade settles in one business day (T+1)

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14
Q

The options market closes at

A

4:00pm ET (3:00pm CT)

same as the normal closing time for most stock markets (open from 9:30am - 4:00pm ET Monday through Friday).

Although options cannot be traded after 4:00pm ET on the expiration date, option holders have until 5:30pm ET to contact their broker-dealer and request their contract be exercised.

Third Friday of the month at 11:59pm ET - expires
Trade cutoff is 4:00pm ET
Exercise cutoff is 5:30pm ET

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15
Q

Long 1 ABC Jan 40 call @ $5

A

-buy
“1” contract (usually covers 100 shares of stocks)
-stock name
-Jan = exp month, exp third Friday of the month at 11:59pm ET (10:59pm CT).
40= strike price (exercise)
-calls are contracts that give the right to buy stock, while puts give the right to sell stock.
-$5 = premium of option (in this case $500 since covering 100)

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16
Q

jumbo contract

vs mini contract

vs standarized option contracts

A

covers 1,000 shares

vs covers 10 shares.

vs 100

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17
Q

Options types

A

refer to calls or puts. All call options are one option type, while all put options are the other option type.

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18
Q

Options classes

A

All calls on a particular underlying security, or
All puts on a particular underlying security

For example, all Target Corporation stock (ticker: TGT) call options are an options class, while all TGT put options are another options class.

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19
Q

Options series

A

All options of a specific class with the same strike and expiration

For example, all TGT Jan 120 call options are part of the same series, while all TGT Jan 120 put options are part of another series.

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20
Q

Call options

A

Holders have the right to buy
Writers have the obligation to sell
In the money (ITM) when the market rises above the strike price
Out of the money (OTM) when the market falls below the strike price
Holders seek ITM options
Writers seek OTM options

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21
Q

Put options

A

Holders have the right to sell
Writers have the obligation to buy
In the money (ITM) when the market falls below the strike price
Out the money (OTM) when the market rises above the strike price
Holders seek ITM options
Writers seek OTM options

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22
Q

Intrinsic value

A

holder’s profit if the option is exercised
“in the money” (ITM) amount of the contract

higher IV = higher premium

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23
Q

Time value

A

time left until an option expires.

The longer the time until expiration, the more potential for the market to move. Therefore, more time value creates a more valuable option with a higher premium.

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24
Q

option premium

A

Premium=intrinsic value+time value

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25
American style options
Can be exercised at any time Typical for stock (equity) options similar to EURO: both can be traded anytime until expiration
26
European style options
Can only be exercised at expiration Typical for index options similar to America: both can be traded anytime on/before until expiration
27
Long call formulas
Bullish investments Right to buy the stock at the strike price Maximum gain = unlimited Maximum loss = premium Breakeven = strike + premium
28
Short calls
Bearish investments Obligation to sell stock at the strike price Considered “naked” without a hedge
29
Short call formulas
Maximum gain = premium Maximum loss = unlimited Breakeven = strike + premium
30
Covers a short call
Long shares Long call Rights or warrants Convertible securities Bank guarantee letter
31
Long puts
Bearish investments Right to sell stock at the strike price
32
Long put formulas
Maximum gain = strike - premium Maximum loss = premium Breakeven = strike - premium
33
cover a short put
Short shares Long put* Cash (equal to the maximum loss) Bank guarantee letter** *For a long put to cover a short put, the long put must maintain the same or higher strike price, plus the expiration must be the same or longer. **A short put is considered covered if a banking institution provides a guarantee letter stating it will cover the costs related to an assignment.
34
short puts
Bullish investments Obligation to buy the stock at the strike price Considered “naked” without a hedge
35
Short put formulas
Maximum gain = premium Maximum loss = strike - premium Breakeven = strike - premium
36
hedging strategy (options)
protecting a stock position with a long option limited risks
37
Long stock with a long put hedge
Market sentiment: bullish Long stock position = fear $ declines, esp significantly perfectly hedget buy long put (right to sell) holding the put but wont want to exercise the put (never want to use your insurance)
38
put goes “in the money”
market price falls below the option’s strike price
39
calls goes “in the money”
market price > the strike price
40
holder wants
ITM
41
writer wants
OTM
42
Short stock with a long call hedge
Market sentiment: bearish With no ceiling to the market, short sellers are subject to unlimited risk. long call options contracts, which provide the right to buy the stock at a fixed price. usually +(short stock) -(premium for call) +(strike if price inc.)
43
Income strategies
selling options against stock positions. Income strategies are typically utilized in flat markets.
44
Covered calls
long stock and short a call options contract The pro - the option’s premium provides the investor added income. = limited loss The con - the option limits the stock’s upside potential = limited income Market sentiment: bull/neutral loss if calls exp worthless gain if calls are exercised. maximum loss = market fall, call OTM ($
45
Covered puts
short stock and short a put options contract Market sentiment: bear/neutral the put goes “in the money” ($ drops as low as $0) and eventually will be exercised (“put down”), limited gain potential the put goes OTM ($ > strike), exp worthless, subject to loss...UNLIMTED
46
collar
hedge wrapper, combines two strategies we learned in previous sections: hedging and income strategies. long stock hedge strategy with a covered call. Short call (“out of the money”) Long stock Long put (“out of the money”) If the market falls too far, the put is exercised, allowing the investor to sell their shares at a higher price than the market. If the market rises far enough, the call is assigned, forcing the investor to sell their shares at a lower price than the market. “Due to the collar and leash, the dog can’t move too far away from its owner.” Provide a cheap or free hedge on stock Call premium offsets the put premium
47
long straddle
cannot confidently predict the market’s direction but believes volatility will exist pays off if the market price rises or falls significantly. Long call & long put* *Must be the same strike price and expiration Long straddle maximum gain=unlimited Long straddle maximum loss=combined premiums Straddle breakevens=strike price +/- combined premiums
48
Short straddles
Short call & short put* *Must be the same strike price and expiration profitable if the market is flat (neutral). two naked (uncovered) options Short straddle maximum loss=unlimited Market sentiment: flat/neutral Breakevens = strike +/- combined premiums
49
combination straddle
if it looks like a straddle, but there’s a difference in the strikes, expirations, or both, it’s a combination.
50
Long combinations
Long call & long put Strike prices and/or expirations are different Market sentiment: volatility limited loss (premium) unlimited gain
51
Short combinations
Short call & short put Strike prices and/or expirations are different Market sentiment: neutrality unlimited loss limited gain (premium)
52
Strangles
Combination with two out of the money options
53
call spread
long and short a call simultaneously. doesn’t matter if the two options have different strike prices, expirations, or if both are different
54
put spread
long and short a put simultaneously. doesn’t matter if the two options have different strike prices, expirations, or if both are different
55
vertical (price) spread
strike prices differences same expiration
56
horizontal (calendar/time) spread
expirations differ same strike
57
diagonal spread
two contracts have different expirations and strike prices.
58
Naming spreads
The dominant leg names the spread
59
Identifying the dominant leg
Highest premium Vertical call spreads: low strike price Vertical put spreads: high strike price Horizontal spreads: long expiration
60
Long call spread
=Bull call spread =Debit call spread
61
Short put spread
=Bull put spread =Credit put spread
62
Butterfly Spread
solid core (short calls for ex) with wings (long higher and lower $ calls for example)
63
4-step spread system
1/ Net premiums Provides max gain or loss 2/Net strike prices 3/Net strike price - net premium Provides max gain or loss 4/Strike price +/- net premium Provides breakeven Call spreads = add net premium to the low strike Put spreads = subtract net premium from the high strike Debit spreads = widen / exercise Credit spreads = narrow / expire
64
4-step spread system
1/ Net premiums Provides max gain or loss 2/Net strike prices 3/Net strike price - net premium Provides max gain or loss 4/Strike price +/- net premium Provides breakeven Call spreads = add net premium to the low strike Put spreads = subtract net premium from the high strike Debit spreads = widen / exercise Credit spreads = narrow / expire
65
Index options
SPX - S&P 500 Tracks 500 large-cap U.S. traded companies OEX - S&P 100 Tracks 100 large-cap U.S. traded companies Subset of the S&P 500 DJX - Dow Jones Industrial Average Tracks 30 large-cap U.S. traded companies RUT - Russell 2000 Tracks 2,000 small-cap U.S. traded companies VIX - Volatility index Tracks market volatility index options are European style, meaning they can only be exercised at expiration EXCEPT OEX index option exercises settle in cash Can be used to hedge against market/systemic risk
66
index option with AMERICAN style
OEX - S&P 100 Tracks 100 large-cap U.S. traded companies Subset of the S&P 500 can be exercised anytime because equity stock options are american
67
writer is required
to deliver ITM (intrinsic value) to holder
68
VIX - volatility index
Also known as the “fear gauge” Negatively correlated with the market Expires on the Wednesday 30 days before the third Friday of the following calendar month worried about volatility = long vix calls , short vix puts (inc value with more volatility, bullish) bearish = bet on market volatility to fall/decrease = short call = bull market
69
Foreign currency options
Derive value from currency fluctuations No U.S. Dollar option speculate on currency values and hedge against currency exchange risk foreign currency option premiums are quoted in cents. ex: concerned about the Yen weakening against the U.S. Dollar (or the Dollar strengthening, which is the same thing) buy the option that profits if the Yen weakens (declines in value) long put (bear = anticipate yen decline) hedge risk , long is better than short if given both options
70
Currency exchange risk
Value is lost due to a currency conversion
71
Foreign currency option units (multiples)
Japanese Yen = 1,000,000 All other currencies = 10,000 foreign currency option premiums are quoted in cents.
72
Yield-based options
Derive value from fluctuating bond yields TYX = 30-year Treasury bond yield index Fixed income securities (e.g., debt securities) lose value when interest rates/yields rise, which is known as interest rate risk. Longer-term bonds, especially those approaching 20-30+ year maturities, are especially exposed to this risk. concerned about interest rate risk, which occurs when interest rates rise, forcing bond market prices downward purchase the option that will profit in case interest rates rise. Interest rates and yields are correlated, meaning they go in the same direction. When interest rates rise, so do yields (because bond prices are falling). Therefore, she should invest in the bullish long TYX call yield-based option.
73
Long option suitability
Speculative growth - capital gains, appreciation Suitable for aggressive investors High risk tolerance
74
Short uncovered option suitability
Speculative income Suitable for aggressive investors Very high risk tolerance
75
Hedging strategy suitability
Long stock with long put Short stock with long call Option provides protection Suitability dependent on position option covers Risk tolerance varies
76
Covered call suitability Income strategies
Long stock with short call (covered call) Provides income in flat/neutral markets Suitable for virtually all investors if the stock position is appropriate Risk tolerance depends on stock position
77
Covered put suitability Income strategies
Short stock with short put (covered put) Provides income in flat/neutral markets Suitable for aggressive investors Very high risk tolerance
78
Long straddle suitability
(long call with long put) Speculative growth in volatile markets Suitable for aggressive investors High risk tolerance
79
Short straddle suitability
(short call with short put) Speculative income in flat/neutral markets Suitable for aggressive investors Very high risk tolerance
80
Spread suitability
Call spreads (long call with short call) Put spreads (long put with short put) Objective depends on the dominant leg Suitable for aggressive investors Moderate to high risk tolerance
81
Five steps to open an options account
Customer fills out a new account form Financial representative provides ODD Account is approved by an options supervisor First trade “opens” the account Customer returns signed options agreement within 15 days
81
Customer information & suitability
Firm must request background and financial information Information will be used to determine the following: ---If account will be approved ---What level of options trading will be allowed Information is confirmed by a negative confirmation letter ---Sent to the customer within 15 days ---Customer only responds if the information is incorrect
82
Options disclosure document (ODD)
Discloses characteristics, risks, and benefits of options Must be delivered prior to options discussion with the retail investor
83
Options agreement
Confirms the investor: ---Received the ODD ---Will abide by OCC rules Signed & returned within 15 calendar days Closing transactions only if not returned within 15 calendar days
84
Registered options principal (ROP)
Series 4 license holder Principal supervisor overseeing options activity May approve options accounts
85
General Securities Sales Supervisor
Series 9/10 license holder Principal supervisor overseeing general brokerage activity May approve options accounts
86
Option exercise process
1 Holder notifies firm of exercise 2 Firm notifies OCC of exercise 3 OCC assigns a firm on a random basis 4 Firm assigns customer using one of: ---FIFO ---Random basis ---Any fair method 5 Holder and writer make delivery within one business day
87
Automatic exercise
Occurs for any contract ITM by $0.01 Investors may submit contrary exercise advice (CEA) to avoid
88
Option contract adjustments
Required for stock dividends or splits
89
Even forward stock splits
Stock splits with a ratio ending in 1 contracts *#/# price / #/# Option contract adjustments: More contracts Lower strike price **Same shares** delivered at exercise (per contract)
90
Uneven forward stock splits
Stock splits with a ratio not ending in 1 Option contract adjustments: **Same number of contracts** Lower strike price More shares delivered at exercise (per contract)
91
Reverse stock splits
Option contract adjustments: **Same number of contracts** Higher strike price Fewer shares delivered at exercise (per contract)
92
Stock dividends
Option contract adjustments: **Same number of contracts** Lower strike price More shares delivered at exercise
93
Cash dividends**
Options are not adjusted for regular cash dividends Options are adjusted for special cash dividends **Same number of contracts** Strike price reduced by the amount of dividend Same shares delivered at exercise
94
Position limits
Prevent large option positions Combine options on the same side of the market -Bullish: long calls and short puts -Bearish: long puts and short calls
95
Exercise limits
Prevents a large number of exercises Covers a five business day period Applies to contracts on the same side of the market
96
financial rep with dicretionary accounts control of many accounts
will be combined in calculating position and excersie limit

Ser 7 (16 decks)

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