Futures and Options strategies

Question 1

What is the purpose of using margin

Answer 1

to increase money made without increasing money invested

Question 2

Margin is

Answer 2

the amount of cash the investor contributes as a percentage of the current market value of the securities held

Question 3

Say you have 50k cash and 50k margin on a 100k investment and the price goes up 20%, what is your percent gain?

Answer 3

20k/50k = 40% gain

vs. if you contributed all 100k the gain would be 20%

Question 4

Say you have 50k cash and 50k margin on a 100k investment and the price goes down 20%, what is your percent loss?

Answer 4

20k/50k = 40% loss

vs 20% loss if you contributed all 100k

Question 5

Margin requirement is

Answer 5

the percentage of the investment that is required to be equity that your cash bought

Question 6

Who sets the initial margin requirement?

Answer 6

The Federal Reserve Board

Question 7

If you have a 60% margin requirement and you want to invest 100k how much cash must you commit?

Answer 7

60k and you can borrow the other 40k

Question 8

Maintenance Margin means

Answer 8

% total equity can drop to before a margin call

Question 9

Say you invest 60k and borrow 40k margin and buy 2000 shares. How low can the price of the investment go before a margin call? Margin requirement is 35%

Answer 9

amount borrowed
————————-
(1-.35)

40,000/.65 = 61,548
61,548/2000 = $30.76 per share

at a value of $61,548 equity is
$61,548 - $40,000 = $21,538

$21,538/$61,538 = .35

To get back to 60% equity needs to be:
.60 * 61,538 = $36,923 (equity needed) - $21,538 (equity you have = $15,385 cash to be added

Question 10

Short selling

Answer 10

borrow the shares from broker hoping the price will fall then buy back at a lower price and return to broker

Question 11

Hedging

Answer 11

making an investment (futures or forward contracts) to reduce the risk of adverse price movement in an asset you either hold or intend to hold in the future

Question 12

Speculator does what

Answer 12

opposite of hedging, investor who buys and sells contracts in anticipation of price changes

Question 13

Short hedge

Answer 13

used by someone long a commodity, stock or currency and will need to sell in the future

Wheat farmer can hedge the price of wheat against price drop

Question 14

Are forward contracts traded?

Answer 14

No

Question 15

Futures for a stock index are settled how?

Answer 15

in cash - don’t receive shares of the index

Question 16

Straddle

Answer 16

simultaneous purchase of a call and a put for the same stock at the same exercise date and same strike price

Question 17

Buyer of a straddle is anticipating what type of movement in the stock?

Answer 17

volatility - allows to exercise both contracts at favorable prices

Question 18

Writer of a straddle is betting on what?

Answer 18

little volatility - a move in one direction is ok. They profit if the underlying asset’s price remains relatively unchanged, avoiding significant movements that could trigger losses on either the call or put option they sold.

Question 19

Spread

Answer 19

simultaneous purchase and sale of an option (call or put) differing only in time or strike price

Question 20

Bull Spread

Answer 20

purchase and sale of calls (net debit, more purchase than sales)

Question 21

Bear Spread

Answer 21

purchase and sale of puts (net credit, more sales than purchases)

Question 22

Collar (zero cost)

Answer 22

used to protect a long position in a stock. Sell a call buy a put. Sell the call at one strike price and buy the put at a lower price.

The put protects you from a decline in the price of the stock. The call will force liquidation if price goes up - locking in a range of prices.

Question 23

Why would you buy a collar?

Answer 23

When an investor has a stock with a large gain they want to lock in

Question 24

Covered call

Answer 24

-sell a call - don’t own the stock
-profit is limited to the premium

Question 25

Naked call

Answer 25

-sell a call - don't own the stock -profit limited to premium -unlimited risk of loss if stock rises

Question 26

Selling a put your profit is limited to what

Answer 26

profit limited to premium

Question 27

Buying a put - loss is limited to what

Answer 27

loss is limited to cost of the put

Question 28

Protective put

Answer 28

-option to sell a specific stock - buy a put in anticipation of price decline - sell a put in anticipation of price rising

Question 29

How can you protect a short with an option?

Answer 29

buy a call in case the stock goes up instead of down

Question 30

Covered put

Answer 30

short a stock, sell a put to cover short

Question 31

Protective put

Answer 31

long a stock, buy a put to protect against loss

Question 32

Black-Scholes Option Valuation Model

Answer 32

used to calculate theoretical present value of a stock based on 5 variables. Allows you to calculate the fair value of an option. Main advantage is speed - allows you to calculate large number of option prices in a short time

Question 33

Black-Scholes only prices an option when?

Answer 33

At expiration - so it's not accurate with American options

Question 34

5 variables for Black-Scholes and Binomial Pricing model

Answer 34

1. Volatility of underlying stock - Standard Deviation 2. Current price of underlying stock 3. Strike price of option 4. Time to expiration 5. Risk free rate of interest

Question 35

Which pricing model would you use for American options? Black-scholes or Binomial?

Answer 35

Binomial

Question 36

Binomial Option pricing model values the option when?

Answer 36

At select periods throughout the life of the option - uses an iterative process to build a binomial tree

Question 37

Which model would you use if you need to price many options at once? Black-Scholes or Binomial

Answer 37

Black-Scholes

Question 38

How to remember a collar

Answer 38

think of it as “protecting your pet” (stock). The call option is like a leash, limiting upside, while the put option acts as a protective collar, limiting downside risk.

Question 39

Way to remember straddle

Answer 39

Picture a straddle as “straddling the fence.” In a straddle option strategy, you’re sitting on the fence, betting on significant price movement—buying both a call and a put option at the same strike price. It’s like preparing for a jump in either direction.

Question 40

Black Scholes think Paul Scoals

Answer 40

British