Options puts and calls

Question 1

Stocks vs. Options (stock ex.)

Answer 1

XYZ stock is currently selling @ $25
I have $2500 to invest so I buy 100 shares

The stock goes to $40 and I sell
$4000 – 2500 = $1500 profit

Question 2

Stocks vs. Options (option ex.)

Answer 2

XYZ option is currently selling @ $3 1/8
I have $2500 to invest so I buy 800 call options

The stock goes to $40 and thus the option goes to 15 and I sell my 800 options
$12,000 – 2500 = $9,500 profit

Question 3

Option:

Answer 3

the right to buy or sell a certain amount of an underlying financial asset at a specified price for a given period of time.

Question 4

Types of options:

Answer 4

• puts
• calls
• warrants
• all of the above are types of derivatives

Question 5

derivatives

Answer 5

have no value in itself (derives its value from how it has been chosen to be used)

Question 6

Puts and Calls:

Answer 6

created by individual investors, not by the organizations that issue the underlying financial asset.

Question 7

Option Buyer:

Answer 7

has the right to buy or sell an underlying asset for a given period of time, at a price that was fixed at the time of the option contract in exchange for paying the seller a fee
- buyer can walk away from a bad option

Question 8

Option Seller/Maker/Writer

Answer 8

• has the obligation to buy or sell the underlying asset according to the terms of the option contract, for which the seller has be paid certain amount of money
• seller cannot walk away from a bad option

Question 9

Call:

Answer 9

• gives the holder (buyer) the right to buy the underlying security at a specified price over a set period of time
• the buyer of the call option wants the price of the underlying assets to go up
• the seller/maker/writer of the call option wants the price of the underlying assets to go down
• hope the market rises

Question 10

Put:

Answer 10

• gives the right to sell at a specified price over a set period of time
• the buyer of a put option wants the market to go down
• the seller of a put option wants the market to go up

Question 11

Calls- a key question ??

Are you covered? Or are you naked?

Answer 11

• you are covered if you own the underlying security
• if you do not own and all you do is trade options then you are naked
• running naked is always riskier than running covered

Question 12

Strike (Exercise) price:

Answer 12

• stated price at which you can buy a security with a call or sell a security with a put

Question 13

Expiration Date:

Answer 13

Date in which the option becomes worthless

Question 14

In the Money call

Answer 14

• when the stock price>strike price (when you make money)

Question 15

Out of the Money Call

Answer 15

• when the stock price< strike price

Question 16

Option Trading Strategies:

Answer 16

• Buying for Speculation
• Hedging
• Writing Options

Question 17

Straddle

Answer 17

• write a put and call, if the stock doesn’t move the writer makes money, both sides will be covered and you make money, if the price does fluctuate (up or down) then you will lose money

-If you think it is going to move then you buy a put and call (can move up or down) lose money if the stock does nothing

Question 18

Hedging with Stock Options

Answer 18

• purpose is to reduce or eliminate risk
• combines two or more securities into a single investment position
• hedging a “long” position
  - buying a put and holding appreciated stock in the same company
  - buying a put would provide “insurance” in case the stock price went down before you sold the stock

Question 19

Writing Stock Options:

Answer 19

• The seller/maker/ writer is betting that the option buyer will be wrong about the direction of the stock price
• statistically, the odds favor the writer over the buyer
  - easy money if the option expires worthless. The writer cannot make more than the fee received
  high risk if the option is “in the money”
  - naked options: writer does not own the optioned securities and has to buy them. No limit on loss exposure
  - covered options: writer owns the optioned securities. Loss exposure is limited to the price originally paid for the securities

Question 20

Equity Collars:

Answer 20

• used by large investors who have accumulated a large position in a given stock and who are primarily concerned about he downside risk of their holdings.
• you give up some of the stocks upside potential in order to obtain the desired downside protection at little or no cost
• equity collar consists of the simultaneous purchase of a put option, and writing of a call option, limit the downside risk by purchasing the put, limiting your upside by purchasing the call
• money you make on the call will make up for loss on the put

Question 21

stock index option:

Answer 21

a put or call option written on a specific stock market index

Question 22

Advantages of Warrants

Answer 22

Offer a chance to benefit indirectly if the common stock price goes up without buying the stock
Low unit cost
Loss exposure is limited to price of warrant

Question 23

Options: Warrants

Answer 23

• a long lived option that gives the holder the right to buy stock in a company at a price specified on the warrant
• have the longest lives of all options, with maturities that extend out 5, 10 or even 20 years
• created by organizations that issue the underlying financial asset
• usually added as “sweeteners” to bond issues
• gives you the right to buy 50 shares of stock at 50 dollars a share, certain share price, doesn’t have to be 50 just example, price tends to be more than share price, if company becomes successful share price goes up but you still pay the same amount you paid at the warrant

Question 24

Disadvantages of Warrants

Answer 24

• have no voting rights
• pay no dividends
• have not claims on assets of the issuing company
• eventually expire