Options Basics

Question 1

What is a call option?

Answer 1

Right (not obligation) to buy an asset at strike K on or before expiry.

Question 2

What is a put option?

Answer 2

Right (not obligation) to sell an asset at strike K on or before expiry.

Question 3

Why buy options?

Answer 3

Speculation (leverage) and hedging (protect downside).

Question 4

What is intrinsic value?

Answer 4

Immediate exercise value:
- Call: max(S − K, 0)
- Put: max(K − S, 0)

Question 5

What is time value?

Answer 5

Time value = Premium − Intrinsic Value. Driven by time to expiry, volatility, interest rates.

Question 6

American vs. European options?

Answer 6

American can be exercised any time; European only at expiry.

Question 7

Why is an American option worth at least as much as a European?

Answer 7

More flexibility → greater value.

Question 8

What is the difference between payoff and profit?

Answer 8

Payoff = value at expiry. Profit = Payoff minus premium paid.

Question 9

What does it mean for an option to be ITM, ATM, OTM?

Answer 9

• ITM: Call S_T > K, Put S_T < K
• ATM: S_T = K
• OTM: Call S_T < K, Put S_T > K