Derivatives Flashcards
(43 cards)
Financial instrument whose value is based on the value and characteristics of another (underlying) security. Created by two investors rather than an issuer of stock and bonds
Derivative
Two parties agree to exchange cash flows based on different financial instruments
Swap Contracts
One party agrees to pay a fixed interest rate, but will receive a variable rate of interest. The other party agrees to the exact opposite. Settled on a net basis, payments will be based on the difference between the fixed and floating interest rates
Interest Rate Swap
Can be created on foreign currencies, commodities, stock prices, interest rates, or even bond defaults
Swap Contracts
In return for assuming the obligation, the writer receives the _____ from the option buyer
Premium
Name of the underlying security, expiration month, exercise price, type and premium
Components of an option
An option will only have an intrinsic value if it is
In-the-money
Amount by which an option is in-the-money
Intrinsic value
Intrinsic Value + Time Value
Option Premium
Portion of an option’s premium that exceeds its intrinsic value
Time Value
Calls are in-the-money if the stock market price is
Above the strike price
Calls are out-of-the-money if the stock market price is
Below the strike price
Puts are in-the-money if the stock market price is
Below the strike price
Puts are out-of-the-money if the stock market price is
Above the strike price of the option
Intrinsic value of an option will either be a _____ amount or _____
Positive amount or zero
Premium associated with at- or out-of-the-money options will consist only of
Time Value
Premium - Intrinsic Value
Time Value
An option’s _________ will diminish with the passage of time and, at expiration, it will have no remaining time value
Time Value
On the final day prior to a contract’s expiration, an ____________ option will be trading very close to its intrinsic value, while an _________ option will be essentially worthless
In-the-money ; Out-of-the-money
Don’t move uniformly when the underlying share price moves, move less than the underlying share price
Premiums
Estimate of the amount by which an option premium will increase or decrease for a $1.00 change in the underlying stock price
Delta
Option positions with positive deltas
Premium will rise as the stock’s price rises, but will fall as the stock’s price falls
In-the-money = Close to +1.0 or +100%
At-the-money = Close to +0.50 or +50%
Out-of-the-money = Close to 0 or 0%
Bullish (i.e., long calls and short puts)
Option positions with negative deltas
Premium will fall as the stock’s price rises, but the premium will rise when the stock’s price falls
In-the-money = Close to -1.0 or -100%
At-the-money = -0.50 or -50%
Out of the money = Close to 0 or 0%
Bearish Options (i.e., long puts and short calls)
Style of option where the option buyer may exercise the contract at any time during its life
American Style
