L7 - Options Flashcards
(25 cards)
What is a futures contract?
An obligation to deliver or purchase a specific commodity as a predetermined time and price
What is an option contract?
An option contract gives the holder the option to buy or sell a specific product at a predetermined time and price
Who gets the option?
The purchaser (long position) of the contract gets the option
- The seller (short position) has an obligation to buy/sell if the option is exercised
What does an option have?
An up-front cost (the price of the option)
What are the 2 basic types of options?
- Call options
- Put options
What are call options?
- A right to buy
- A call option gives the holder/buyer the right, but not an obligation, to buy (or call) the underlying asset, for the given exercise price K, at a future time T
What are put options?
- A right to sell
- A put option gives the holder/buyer the right, but not the obligation, to sell (or put) the udnerlying asset, for the given exercise price K, at a future time t
What are the 2 type of options named after regions?
- American options
- European options
What are American options?
Gives the owner the right to exercise the option on or before the expiration date
What are European options?
Gives the owner the right to exercise the option only on the expiration date
Are American or European options more common?
American options are the most common type of options traded
What type of options will we only analyse?
We will cover methods to analyse European options
What is exercise date (T)?
The date at which the option can be used, usually specified in the contract. It is also known as the expiration date or the maturity date
What is the exercise/strike price?
The price at which the option holder can purchase the stock (or other underlying asset)
What is the long position in a call option Ct?
Ct = max{0, St - K}
What is the short position in a call option?
min{K - St, 0}
What is the long position in a put option?
Pt = max{0, K - St}
What is the short position in a put option?
min{St - K, 0}
What does moneyness refer to?
Whether an option is in-the-money or out-of-the-money
What does it mean if an option is ‘in-the-money’?
An option is in-the-money when immediate exercise of the option will generate a positive payoff for the holder
What does it mean if an option is out-of-the-money?
An option is out-of-the-money when immediate exercise will generate a negative payoff for the holder
What does it mean if an option is at-the-money?
When immediate exercise will result in neither a positive nor a negative payoff for the holder
What does binomial option pricing enable us to determine?
The price of an option, given the characteristics of the stock or other underlying asset
What does the binomial option pricing model assume?
That the price of the underlying asset follows a binomial distribution - that is, the asset price in each period can move only up or down by a specified amount
