Options

Question 1

what are the two types of options

Answer 1

calls and puts

Question 2

what is a call option

Answer 2

gives the holder the right but not the obligation to buy an asset on a certain date for a certain price

Question 3

what is a put option

Answer 3

gives the holder the right but not the obligation to sell an asset on a certain date for a certain price

Question 4

what must be specified in an option contract

Answer 4

• what you are buying or selling (the underlying)
• is it a call or a put
• whether you are buying or selling the option (long or short)
• when the asset can be bought or sold (Expiry date)
• at what price (strike price)
• the price of the option (option premium)

Question 5

what is the strike price

Answer 5

the price at which it is agreed the asset will be bought or sold

Question 6

what is the option premium

Answer 6

the money that changes hands when the option is agreed upon

Question 7

what does the premium of the option depend on

Answer 7

where the strike price is in relation to the price of the underlying

Question 8

if the strike price of a call is lower than the underlying price currently will the premium be higher or lower

Answer 8

higher

Question 9

if the strike price of a put is higher than the underlying price currently will the premium be higher or lower

Answer 9

higher

Question 10

if you are setting strike price for call option what is your goal

Answer 10

to buy as cheap as possible

so set as low as possible

Question 11

if you are setting the strike price for a put option, what is your goal

Answer 11

to sell for as much as possible

so set as high as possible

Question 12

if the option is at the money what does this mean

Answer 12

the strike price = forward price

Question 13

if the option is in the money what does this mean

Answer 13

call : strike price is lower than the forward price (better off as you can buy more cheaply)

put : strike price is higher than the forward price (better off as you can sell for more money)

Question 14

if an option is out of the money what does this mean

Answer 14

call : strike price is higher than the forward price (worse off as you must pay more)

put : strike price is lower than the forward price (Worse off as you must sell for less)

Question 15

how does the option change in value throughout its lifetime

Answer 15

as the price of the underlying asset changes, the value of the option changes

Question 16

do owners of call options want the price of the underlying to increase or decrease in order to profit

Answer 16

increase

Question 17

do owners of put options want the price of the underlying to increase or decrease in order to profit

Answer 17

decrease

Question 18

an example of when you would not exercise a call option

Answer 18

when the price of the underlying goes down and it is cheaper to buy it in the market

Question 19

an example of when you would not exercise a put option

Answer 19

when the price of the underlying goes up and it is more profitable to sell at its current market price

Question 20

what must also be taken into account when considering the profts

Answer 20

sunk cost from upfront premium payment

Question 21

difference between option contracts and future/forward contracts

Answer 21

option = not obliged to exercise where as future/forward must be exercised

option = premium paid where as future/forward has no money changing hands initially

Question 22

who gets to hold onto the premium if the option is not exercised

Answer 22

the seller

Question 23

where is the kink point in an option contract diagram

Answer 23

strike price

Question 24

which has limited upside: a put or call

Answer 24

put

because there is a limited maximum payout.

if the price goes down you make money. but if the price goes up, which can be infinite, you lose money

Question 25

why does a call option have an unlimited upside

Answer 25

if the price goes down, you lose money

but if the price goes up, which it can infinitely, you are saving money

Question 26

if you are a owner of a put option, and the prices go up, what do you wish you had

Answer 26

a forward contract

Question 27

if you are the owner of a call and the prices go down, what do you wish you had

Answer 27

FORWARD

Question 28

if you are bullish about the price of an asset, what could you do as an investor

Answer 28

buy it

buy forward/future on it

buy option on it

Question 29

if you are bearish about the price of an asset, what could you do as an investor

Answer 29

short the asset

short the future

buy a put option

Question 30

if you already own an asset and you are worried about it falling in price what could you do

Answer 30

sell it

short forward/future contract

buy put option

Question 31

what is a protective put

Answer 31

like insuring an asset you own

you buy a put on an asset you think may fall in price

the cost of the insurance is the cost of the underlying

Question 32

what is a covered call

Answer 32

selling a call option on stock you already own

it is a way to generate an income from an asset that you don’t think will go up in price

Question 33

what is the risk with covered calls

Answer 33

if the price of the asset does go up, you give up the chance of the upside

Question 34

what is a straddle

Answer 34

buying a combination of a put and a call on the same asset with the same strike price

if asset moves either way you profit

Question 35

what is a straddle a trade on

Answer 35

volatiliry

Question 36

example of when you would use a straddle

Answer 36

when the outcome is unknown

eg brexit
eg pharmaceutical drug test trial

Question 37

if you want to short straddle what must you do

Answer 37

sell a call and put option with the same strike price

Question 38

what is a short straddle a trade on

Answer 38

little to no volatility