Derivatives Flashcards
Derivatives
contract between two parties that derives its value from underlying assets like stocks, bonds, commodities, currencies, interest rates, and market indexes.
Option
two party contract. One party has the right to buy or sell underlying security, and the other is obligated to fulfill the terms of the contract.
Contract- Buyer and Seller
Buyer- Purchaser or holder, Long, Pays Premium, Owns the Right, Is in Control.
Seller- Writer, Short, Receives Premium, and Takes and Obligation.
Long Call (Purchase)
owns the right to buy more shares at a strike price. call buyers are bullish, who anticipates the price of the securities will rise above the strike price.
Short Call (Sale)
has the obligation to sell shares at a strike price. call writer is a bearish investor, who anticipates the price of the securities will fall or stay the same. keeps the premium with no further obligation.
Long Put (Purchase)
owns the right to sell shares at a strike price. Put buyer is a bearish investor who wants the price of the security to drop.
Short Put (Sale)
writer has the obligation to buy shares at a strike price. put writer is a bullish wants the prices to rise or remain the same.
Index Options
tracks the performance of a particular group of stocks, S&P 500 and Dow Jones. Settled in cash.
Vix Options
designated to measure expected volatility of the US stock. “fear index” spokes upwards when the stock market moves downward.
Calls ( In, At, Out of the money, Intrinsic Value, and Parity)
In the money- price of stock exceeds strike price. Buyers will call. (Sellers do not want this to happen)
At the Money- Price of the stock equals the strike price. Buyers will not call at expiration. (Sellers keep premium)
Out of the Money- Price of the stock is lower then the strike price. Buyers will not call at expiration. (Sellers keep premium)
Intrinsic Value- Market price of the stock is above the strike price. Always positive amount or 0. At or Out of the money will have intrinsic of 0. Buyers like IV, sellers do not.
Parity- Premium = Intrinsic Value.
Puts (In, At, Out of the money, Intrinsic Value and Parity)
In the money- Price of the stock is below the strike price. Buyers will put. (Sellers do not want this to happen)
At the money- Price of the stock equals the strike price. Buyers will not put at expiration. (Sellers wants)
Out of the money- Price of the stock is above the strike price. Buyers will not put in expiration. (Sellers wants)
Intrinsic Value- Market price of the stock is below the strike price of the put. Buyers like IV sellers do not. A put with NO IV value will simply expire.
Parity- Premium equals Intrinsic Value.
The Premium Formula
Intrinsic Value + Time Value = Premium
Premium - Intrinsic Value = Time Value
Index Options
allows investors to profit from the movement of the market and hedge against these market swings.
Broad- Based Indexes
Reflect movement of the entire market. Stop trading at 4:15pm ET
Narrow- Based Indexes
Track the movement of a market segment of a specific industry for example, technology or pharmaceutical. Stop trading at 4:00pm ET
Index Option Features
Strike Price X 100 = total dollar value of the index.
- Settles in cash
- Cash delivered next business day
- Expire on the third Friday of the month expiring.
Index Option Strategy
Investor believes the market will rise- Investor purchases index calls or write index puts.
Investor believes the market will fall- Investor can purchase index put or write index call.
Portfolio Insurance
Hedging of a portfolio. With a diverse portfolio of equity, investor can buy a put on the index to offset loss of the market value of the stocks falls.
Interest Rate Options
are yield based that have a direct relationship to movements in interest rate. Based on T- Bills, T- Notes, and T-Bonds.
Currency Options
performance of currencies other then the US dollar OR to protect against fluctuating currency exchange rates against US dollar. Used by Importers and Exporters to hedge fluctuations in the currency exchange.
- Expires on the third Friday of the month expiring.
- Settles next business day
- European Style exercise only.
EBP
Exports Buy Puts
IBC
Imports Buy Calls
American-Style
allows owners of a contract to exercise anytime BEFORE the expiration date. All equity and equity index.
European- Style
can only be exercised ON the expiration date. Foreign currency and yield based options.
