Unit 4 (Series 7)
Writing Puts
-Max gain = premium -Max loss = strike price - premium
Buying Puts
-Protecting of a long stock option -Max gain = strike price-amount of premium paid -Max loss = premium
Writing Calls
-Protection of a long stock position -Max gain = premium -Max loss = unlimited
Buying Calls
-Protection of a short stock position -Unlimited gain -The most the call buyer loses is the premium
All of the following option positions have limited potential loss EXCEPT: A) long puts. B) long calls. C) short uncovered puts. D) short uncovered calls.
D) short uncovered calls.
All of the following actions must be completed prior to a customer entering his first option trade EXCEPT: A) completion of the options agreement. B) completion of the new account form. C) delivery of an OCC Disclosure Booklet. D) approval by a sales supervisor.
completion of the options agreement. Customers do not have to complete (sign) the options agreement prior to entering an order, although, under exchange rules, the agreement must be signed and returned by the customer within 15 days of account approval.
Combination
composed of a call and a put with different strike prices, expiration months or both
Straddle
composed of a call and a put with the same strike price and expiration month
Registered Option Principal (ROP)
handles compliance and supervisory issues regarding customer options business. Approves all options literature (advertising/sales) intended to communicate with the public
Ratio call writing
involves selling more calls than the long stock position covers. This generates additional premium income for the investor but also entails unlimited risk
Time (calendar/ horizontal) spread
option contracts with different expiration dates but the same strike prices
Intrinsic value (put)
premium - strike price
Put call ratio
reflects the current open interest in the trading of put options to call options. Can be used to gauge investor sentiment (bullish/bearish). As the ratio increases it can be interpreted as a indication that investors have felt the market sector would move lower
Market Makers
registered with the exchange to trade for their own accts. They must stand ready to buy or sell options
Covered call writing
selling calls when holding a long stock position. Could be written to improve the return on a portfolio.
Options agreement
states that the customer has read the disclosure document , understands the risks of options trading and will honor position limit rules and will advise if their finances change, must be returned in 15 days of acct approval
Call straddle breakeven
strike price + both premiums
Put straddle breakeven
strike price - both premiums
Intrinsic value (call)
strike price - market price
Supporting
the act of entering purchase orders in a stock for the purpose of keeping the price from falling below the strike price of puts one is short - keeps puts of money
Capping
the act of entering sell orders in a stock for the purpose of keeping the stock from rising above the strike price one is short
Options Clearing Corporation (OCC)
the clearing agent for listed options contracts and is owned by the exchanges that trade options, designates the strike prices and expiration months for new contracts
Long straddle
the investor expects substantial volatility in the stocks price but is uncertain of the direction the price will move Max gain: unlimited Max loss: total premiums paid
Short straddle
the investor expects that the stocks price will not change or will change very little Max gain: total premiums paid Max loss: unlimited
Time value
the markets perceived worth of the time remaining to expiration. Intrinsic value - premium
Diagonal spread
the options differ in both time and price
Systemic risk
the risk of a decline in the overall market
Spread
the simultaneous purchase of one option and sale of another option of the same class
Portfolio insurance
the use of index puts
If a customer does not anticipate that a stock's price will change and he wants to take an option position, he would most likely: A) buy a call. B) write a straddle. C) buy a put. D) buy a straddle.
write a straddle.
Interest rate options
yield based, based on the yields of T-bills, T-notes and T-bonds. Each point is worth $100. European style exercises.
Open long option
Buy contract
Price (vertical) spread
Different strike prices but the same expiration date
Short stock protection
Full: Long call Partial: Short put
Long stock protection
Full: Long put Partial: Short call
Which of the following are spreads? I)Long 1 FLB May 40 call; short 1 FLB May 50 call. II)Long 1 FLB May 40 call; long 1 FLB May 50 call. III)Long 1 FLB Aug 40 call; short 1 FLB May 40 call. IV)Long 1 FLB Aug 40 call; short 1 FLB Aug 50 put.
I and III.
Standard Options Trading (exercise dates)
Regular way basis (3 business days)
Holding period required for short-term capital gains treatments
12 months ore less before the purchase of a put
If a customer is short 100 XYZ shares at 54 and long 1 XYZ 55 call at 2, what is the maximum potential loss?
300 the most the customer can lose is $100 on the stock position (the difference between the option strike price and short sale price), plus the premium paid for the option ($100 + $200 = $300).
Foreign Currency Options (expiration dates)
3rd friday of the expiration month
Stock index options (expiration dates)
3rd friday of the expiration month
Credit =
= narrow = expire
Debit =
= widen = exercise
Which of the following option strategies besides going long a call can be used to purchase stock below its current market value? A) Short put. B) Short call. C) Short straddle. D) Long put.
A) Short put. If the put is exercised by the owner the writer of the put will be obligated to purchase the stock. The cost of the stock is reduced by the amount of premium taken in when the put was written allowing the investor to purchase the stock at a net cost lower than the stock's current market value.
An investor opens the following position: Buy 1 COD Jan 40 put at 6.50 Write 1 COD Jan 30 put at 2.10 His maximum loss is: A) 440. B) 2100. C) 2600. D) 560.
A)440
Options contract adjustments
Adjustments to the # of shares are rounded down to the next whole share. When even stock splits occur additional options contracts are created. (ex 2:1, 3:1, 4:1 split)
Ratio write
An investor establishes a ratio write by writing calls that represent more shares than he owns.
Neutral
An investor who writes an at the money put profits even if the market doesnt move
A customer recently approved to trade options writes an OEX put for the account's initial transaction. If the customer fails to return the signed option agreement within 15 days of account approval, which of the following transactions is the customer permitted to make? A) Closing sale. B) Closing purchase. C) Opening sale. D) Opening purchase.
B) Closing purchase
Which of the following is TRUE regarding option contracts that expire weekly? A) They can only be traded for a single day. B) They tend to have lower premiums than standard contracts or long-term equity anticipation (LEAP) contracts. C) They expire on Mondays. D) They are issued every week of every month.
B) They tend to have lower premiums than standard contracts or long-term equity anticipation (LEAP) contracts. Weekly contracts or "weeklies" tend to have lower premiums than other types of contracts due to the short period of time between when they are issued and when they expire (1 week). They can be traded anytime during their week-long life cycle, expire on Fridays, and are issued each week of the month except the week that standardized contracts would be expiring.
Debit put spread
Bearish: Breakeven = net premium - higher strike price
Credit call spread
Bearish: Breakeven= net premium + lower strike price
Covered call Breakeven
Breakeven = premium - stocks purchase price
If you buy the lower strike price, you are bullish or bearish?
Bullish
Credit put spread
Bullish: Breakeven= net premium - higher strike price
Debit call spread
Bullish: Breakeven= net premium + lower strike price
How do you hedge a short stock position?
Buy a call or with a long call.
How would an importer hedge on foreign currency?
Buy calls
Close short option
Buy contract
Bull spread
Call buyer, Put seller Want to see stock price go up
A foreign company that exports its products to the United States wishes to protect itself during a time in which the U.S. dollar is expected to be devalued. The company should: buy U.S. dollars. sell U.S. dollars. buy foreign currency. sell the foreign currency.
D) II and III. sell U.S. dollars. buy foreign currency If the company expects the U.S. dollar to become devalued, that means that the foreign currency will become worth more. It would make sense at this time, therefore, for the company to get rid of its U.S. dollars, which are expected to decline in value, and acquire the foreign currency, which will appreciate relative to the U.S. dollar.
After being approved for options trading, a customer establishes several long option positions but does not return the signed option agreement within the required time period. The broker/dealer may: A) only allow the customer opening transactions. B) sell out the customer's positions and freeze the account for 90 days. C) permit no further transactions until the signed agreement is returned . D) only allow the customer closing transactions.
D) only allow the customer closing transactions.
Which of the following terms is synonymous with an option's market value? A) Exercise price. B) Strike price. C) Multiplier. D) Premium.
D) Premium The premium is the cost or price at which the option can be bought or sold in the market. The strike price or exercise price is the cost to exercise the option, while the multiplier indicates contract size.
Debit spread
If the long option has a higher premium than the short option Max gain= strike price- net debit Max loss= net debit
Credit spread
If the short option has a higher premium than the long option Max gain= net credit Max loss= strike price-net credit
Calls: CMV > SP
In the money
Puts: CMV < SP
In the money
In a 2 for 1 adjustment will the # of contracts owned increase or decrease?
Increase
Debit (DR)
Money paid out to the investors acct
Credit (CR)
Money received to the investors account
Holding period required for long-term capital gains treatment
More than one year
Foreign Currency Options (exercise dates)
Next business day
Does the Options Clearing Corporation designate the premium for contracts?
No, the market determines that
What can the customer do if the underlying security is halted?
Options trading is halted, the customer may still issue exercise intstructions
Calls: CMV < SP
Out of the money
Puts: CMV > SP
Out of the money
Which of the following investors will sell stock if an option is exercised?
Owner of a put and Writer of a call
Parity
Premium = intrinsic value
Most common spread?
Price (vertical)
Bear spread
Put buyer, Call seller Want to see the stock price go down
Equity option (exercise dates)
Regular way (3 business days)
Close long option
Sell contract
Open short option
Sell contract
Stock index options (exercise dates)
Settles in cash, cash must be delivered on next business day.
Call Breakeven:
Strike price + premium
Customers seeking to open an options acct may be granted approval by?
The branch manager wiht subsequent approval of a ROP
Call spread (Market attitude)
The lower strike price has the higher premium
Put spread (Market attitude)
The option with the higher strike price has a higher premium
What should a foreign agency do if there are no listed currency options available on U.S. currency?
They should buy calls on its own currency
When must a new options customer return a signed option agreement?
Within 15 days of the account approval.
Which of the following transactions would be acceptable investments for a pension fund?
Writing a covered call Writing a covered call has less risk than writing a naked option. A covered call writer is merely using options to increase the income on his portfolio. Fiduciaries such as those who invest for pension fund portfolios should avoid risky transactions.
Which of the following strategies is considered most risky in a strong bull market?
Writing naked calls. Writing naked calls gives unlimited risk.
Floor brokers
a firms rep on the floor. They execute orders on behalf of the firm and its customers
Designated primary market maker (DPM)
a floor trader responsible for maintaining a two-sided market for a specific product on the CBOE and is the trading firm. All equity options on the CBOE have a DPM
Beta
a measure of the volatility of a stock or a portfolio related to the volatility of the market in general
Customers seeking to open an options account may be granted approval by the:
branch manager initially, with the subsequent approval of a ROP.
Volatility market index (VIX)
designed to reflect investor expectations of market volatility over 30 days. "Fear" gauge or index
Uneven/ fractional split
does not create additional options contracts (ex 3:2 or 5:4)
Net debit
equals maximum loss. Find the max gain by subtracting the net debit from the difference in the two strike prices
OCC Options Disclosure Document
explains options strategies, risks and rewards and is designed to provide full and fair disclose to customers before they bin options trading
