Chapter 15- Investments

A stock can be replicated by:

- A long call - A short put - A t-bill

Put writer

- Buying at the strike price - Selling contracts for others to sell

3 things that will not change throughout the life of an option

- Identity of the underlying stock - Strike price - Expiration month

A put and call option have the same maturity and strike price. If they also have the same price, which one is in the money?

- Put The stock price must be equal to the present value of the strike price

Options on common stock must stipulate at least the following six contract terms

1. The identity of the underlying stock 2. Strike price 3. Option contract size 4. Option expiration date 5. Exercise style 6. Delivery or settlement procedure

A single call option contract involved an option to buy ____ shares of stock

100

What would replicate a put option

A short option

Stock index option

An option on a stock market index

American options

An option that can be exercised any time before expiration

European options

An option that can be exercised only at expiration

Out of the money

An option that would not yield and positive payoff

In the money

An option with a positive intrinsic value

At the money

Any option with a strike price exactly equal to the underlying price

Call options

Confers to the right, without the obligation, to buy an asset at a given price on or before a given date

Put options

Confers to the right, without the obligation, to sell an asset at a given price on or before a given date

The exchange eliminates

Counterparty risk

You make money if the stock price _____

Declines

Strike price is also called

Exercise price

The seller of a call option receives money

For the right to sell

If interest rates go up, the value of the option:

Goes down

If the underlying stock price is _______ than the strike price, the intrinsic value for a put option is set to zero

Greater

One reason you would buy a put option

If you antcipate the price will decrease

At expiration, the value of an option is equal to:

Intrinsic value because no time is left at expiration

Spread strategy

Involves taking a position on two or more options of the same type at the same time

Before expiration, the value of an option equals:

Its intrinsic value plus its time value

If the underlying stock price is _____ than the strike price, the intrinsic value for a call option is set to zero

Less

What is the intrinsic value of a put option?

Max (0, K-S)

What is the intrinsic value of a call option?

Max (0, S-K)

The _____ time you have, the more valuable the option

More

When you sell a call option that you already own, you keep the ______

Option premium

Strike price

Price specified in an option contract that the holder pays to buy shares

The CDS acts like a protective

Put option

Derivative security

Security whose value is derived from the value of another security

Writer

Seller of an option

Covered call

Selling a call option on stock already owned

Call writer

Selling at strike price if the option is exercised

Call option intrinsic value

Stock price- strike price

Put option intrinsic value

Strike price- stock price

Combination

Takes a mixture of call and put options

A put and a call option have the same maturity and strike price. If both are at the money, which is worth more?

The call is worth more - The call option offers a much bigger potential payoff, since its theoretically unlimited, so its worth more

The breakeven price for a call purchase

The exercise price plus the premium paid - For stock prices higher than this, the purchaser realizes a gain

The greater the standard deviation:

The more valuable the option may be

The seller of a put option receives money for

The obligation to buy

Premium

The price the option trades at

The buyer of a call option pays money for

The right to buy

The buyer of a put option pays money for

The right to sell

The breakeven price for a put purchase

The strike price less the premium

A call option has:

Unlimted potential profit - Put option has limited potential profit

Intrinsic Value

What the option would be worth if it were expiring immediately

Investors can calculate intrinsic value:

Whether the option is dead or alive

One reason you would buy a call option

You expect the price of the asset to increase

At expiration, the time value of an option is ______

Zero