chapter 4 Flashcards
(42 cards)
Covered call
Long stock, short the call Draw it out to find max gain/loss/breakeven Normally done in stable market Limits upside Can be used by pension (not risky)
Protective Put
Long stock, buy put
Draw out
Max again unlimited
used to protect portfolio
OCC
standardize, guarantee performance of ptions, exercise of options guaranteed, (market determines premium)
Excercise notice on random basis
option contract w/o certificate
OCC exercise rules limit the maximum number of contracts in the same underlying security that can be exercised within a 5 business day period. Three customers, all related, and all giving instructions to exercise their long calls in the same underlying security within 3 business days should, at a minimum, raise the question of whether or not they are acting in concert in order to circumvent the OCC exercise limit rules.
The client must have a current OCC disclosure document. This is verified by the client’s signature on the options agreement form which must be signed and returned within 15 days of account approval. The client must agree to notify the firm of any changes in financial status as soon as possible and the options agreement amended if necessary. OCC approval for an options account is not required nor do they verify any information given by the client.
Price/Vertical Spread
Same expiration date, different strike price
Most common spread (heavily tested)
Time/Calendar/horizontal spread
Different expiration dates but the same strike price, expect limited volatility
Debit call spread
Used by investors to reduce cost of long options
Bullish
Long lower SP option
Pay net premium
To find breakeven: Add the net premium to the lower SP
Buy call/ sell call
Debit spread profitable when widen and exercise
Long straddle
expect substantial volatility
Purchase a long put and call with the same strike price and same expiration date on the same stock
Two breakevens; adjust by net premium on both sides
Draw out
Foreign currency options
Cash settled in USD, no physical delivery
1 point - $100
Options expire third Friday of expiration month
Settle on next biz day
USD not available
Put-Call Ratio
Higher the ratio, more bearish investors have been up to that point in time
Can be contrarian indicator
Married put
Customer buys stock and buys put option on that stock
Cost basis of stock must be adjusted upward by the premium
Timing OCC Disclosure book
at the time of or before account approval
How to tell if spread (call or put) is bullish
If buying the lower strike price, BULLISH
Diagonal spread
two options of the same type with different expiration dates and strike prices
Tax consequences call buyers, option expires worhtless
Buyer reports capital loss equal to premium, seller CG equal to premium
LEAPS writers at expiration
Must report short term capital gains at expiration
solving for # options to hedge, taking into account beta
Portfolio value/ market value of index
Multiply the result by beta
Solving breakevens for Call spreads and put spreads
CAL: Call spreads, add net premium to lower SP
PSH: Put spreads, subtract net premium from higher SP
Yield based options settle
Yield based options settle in cash if the option is exercised. The writer must deliver the in-the-money amount in cash.
Buy LEAP
A LEAPS contract has an expiration of more than one year. Upon expiration, the buyer incurs a long-term capital loss equal to the amount of the premium paid.
Index option settlement
All index option exercises are settled in cash. The amount a writer owes the holder is known as the intrinsic value of the option, and the settlement value is based on the closing index value on the day exercise instructions are tendered. Exercise settlement is next business day.
In contrast equity options settle regular way (T+2)
Reference: 4.5.1 in the License Exam Manual
Adjusted options for stock dividends
When adjusting options contracts for stock dividends and fractional splits, the number of contracts held will not change. The number of shares covered by each contract is increased (100 shares × 120%) so that in this example each adjusted contract now represents 120 shares. The effective exercise price is adjusted so that the position value remains the same before and after the adjustment. Therefore the new strike price will be 50 ($6,000 / 120 shares = $50).
Currency Quotes
Currency options are quoted in U.S. cents per dollar and one point equals $100. A quote of 11.00 is equal to $1,100 per contract.
Yield based debt options
Yield-based debt options are European style contracts meaning that they can only be exercised on the last day of trading. All yield-based contracts when exercised are settled in cash. There is no delivery of debt instruments when these contracts are exercised. All strike prices reflect yield (35 strike price represents 3.5% yield).
Ratio writing
ratio writing where a customer writes more calls than he has stock to cover. Because only one of the calls is covered, the other is uncovered and loss potential is unlimited.
The client is writing more calls than he has stock to cover. The first call is covered by the 100 shares of stock owned, but the second call is uncovered, or naked. A short naked call has unlimited loss exposure.
