Topic 5 options and basics features of risk management Flashcards
(23 cards)
What is an option in financial terms?
An option is a derivative financial instrument, meaning its value is derived from the value of another underlying financial instrument.
What is the key feature of an option contract?
The buyer of an option has the right but not the obligation to buy or sell an underlying asset at a specified price at a specified time.
What does a call option give the holder?
A call option gives the holder the right, but not the obligation, to buy an asset at a specified price at a specified time.
What does a put option give the holder?
A put option gives the holder the right, but not the obligation, to sell an asset at a specified price at a specified time.
What is the strike price of an option?
The strike price is the specified price at which the underlying asset can be bought or sold when exercising an option.
What is the option premium?
The option premium is the cost paid to purchase an option contract.
What is the expiration date of an option?
The expiration date is the date by which the option must be exercised or it will expire.
What is the difference between European-style and American-style options?
A European-style option can only be exercised on the expiration date, whereas an American-style option can be exercised up to and including the expiration date.
What is the payoff of a call option when the market price is below the strike price?
The payoff is zero because it would be cheaper to buy the asset in the market than exercise the option.
What happens to the payoff of a call option when the market price is above the strike price?
The payoff increases one-for-one with the excess of the market price over the strike price.
What is the break-even point for a call option?
The break-even point is when the market price of the asset equals the strike price plus the option premium.
What happens if the market price is below the strike price for a put option?
The holder of a put option can sell the asset at the strike price, profiting from the difference between the strike price and market price.
What is the payoff for a put option when the market price is above the strike price?
The payoff is zero because the option would not be exercised since it would be better to sell the asset at the market price.
What is the profit from writing a call option?
The writer of a call option profits by receiving the option premium if the market price is below the strike price, but incurs a loss if the market price exceeds the strike price.
What is the break-even price for the seller of a call option?
The break-even price is the strike price plus the option premium.
What is a long straddle strategy?
A long straddle involves buying both a call and a put option with the same strike price and expiration date, profiting from large price movements in either direction.
How do volatility expectations affect the pricing of options?
Options premiums tend to increase with higher expected volatility of the underlying asset.
What is the Black-Scholes option pricing formula?
The Black-Scholes formula is used to calculate the value of a call option based on factors such as the stock price, exercise price, time to expiration, and volatility.
What does the cumulative normal probability function (N(d)) represent in the Black-Scholes model?
N(d) represents the cumulative probability that a stock price will be above or below a certain value, based on the option’s characteristics.
How is implied volatility calculated in the Black-Scholes model?
Implied volatility is derived from the market price of the option and represents the expected volatility of the asset over the life of the option.
What is the purpose of a volatility index?
A volatility index measures the market’s expectations of future volatility, often calculated from option prices.
What happens if the option holder does not exercise the option by the expiration date?
If the option is not exercised by the expiration date, it expires worthless and the option holder loses the premium paid.
