L8 - FRM 1

Question 1

What is a call option?

Answer 1

A call option gives the holder the right but not the obligation to buy an asset at a specified price on or before a certain date

Question 2

What is a put option?

Answer 2

A put option gives the holder the right, but not the obligation to sell an asset at a specified price on or before a certain date

Question 3

Define strike/ exercise price:

Answer 3

The fixed price in the option contract at which the option holder can buy or sell the underlying asset

Question 4

Define intrinsic value of a call option

Answer 4

Max (St - X), where St is the asset price at expiry and X is the excersise/ strike price

Question 5

Define intrinsic value of a put option

Answer 5

Max (X - St), where St is the asset price at expiry and X is the exercise/ strike price

Question 6

Define time value of an option

Answer 6

The difference between the option premium and the intrinsic value

Question 7

How can options be used to hedge?

Answer 7

By combining the underlying asset with an option or options to reduce or eliminate downside risk

Question 8

What is the role of the option seller (writer)?

Answer 8

The seller has an obligation to fulfil the contract if the buyer exercises their right