Options Flashcards
(21 cards)
Option premium
Purchase price of the option
Exercise/strike price (K)
Price at which you buy or sell the security.
In-the-money option
Exercise of option produces positive cash flow
➢ Call: exercise price < asset price: (K<ST)
➢ Put: exercise price > asset price: (K>ST)
At-the-money option
Exercise price and asset price are equal (ST=K)
Out-of-the-money
option
Exercise of the option would not be profitable
➢ Call: asset price < exercise price: (ST<K)
➢ Put: asset price > exercise price: (ST>K)
Expiration Date
Last date on which the option can be exercised.
American option
Can be exercised at any time before expiration or maturity
(most options in U.S. except currency and stock index options).
European option
Can only be exercised on expiration date.
What is the Call option payoff?
Max[0, ST - K]
What is the put option payoff?
Max[ST - K, 0]
Long
Option purchaser
Short
Option seller
Long call
The right but not obligation to buy shares of the underlying asset at a certain strike price
Short call
The potential obligation to sell 100 shares of the asset upon demand
Long put
The right but not the obligation to sell 100 shares of the underlying asset at a certain strike price
Short put
The potential obligation to buy 100 shares of the asset upon demand
What is a protective put?
A protective put is a strategy that combines owning a stock and buying a put option on the same stock. It limits downside risk while maintaining upside potential.
What is put-call parity?
Put-call parity is a relationship between the prices of European call and put options.
It’s expressed as:
C + PV(K) = P + S
Where C = call price, P = put price, S = stock price, and PV(K) = present value of strike price.
What factors affect option pricing?
Current stock price
Strike price
Time to expiration
Risk-free interest rate
Volatility of the stock
Expected dividends
What is the Binomial Option Pricing Model?
It’s a model that assumes a stock can move to one of two prices in each period and uses backward induction to compute the value of an option.
What is the Black-Scholes model?
A continuous-time model used to price European options. It assumes no arbitrage, constant volatility, and the ability to trade continuously.
