4.2 Options

Question 1

Types of options, explained

Answer 1

• Call: the right to buy an asset for a given price (exercise price) on or before a given date (expirationn date).
• Put: the right to sell an asset for a given price on or before the expiration date.

Question 2

Exercise styles, explained

Answer 2

• European: owner can exercise the option only on expiration date.
• American: owner can exercise the option on or before expiration date.

Question 3

4 elements of an option

Answer 3

• Underlying asset, its price S, volatility and dividend (if any).
• Exercise price (strike price) X
• Expiration date (maturity date) T - today is 0
• Exercise style (European or American)

Question 4

Payoff diagrams for long calls

Answer 4

Payoffs on y-axis. Stock price on x-axis.

Question 5

Payoff diagrams for long puts

Answer 5

Payoffs on y-axis. Stock price on x-axis.