Finance - Ch. 20 Financial Options
Option seller (writer)
-Sells (or writes) the option and has a SHORT position in the contract -Because the long side has the option to exercise, the short side has an obligation to fulfill the contract if it is exercised
stock options contracts are always written on how many shares of stock?
100 shares
Which of the following positions benefit if the stock price increases? A. Long position in a call. B. Long position in a put. C. Short position in a call. D. Short position in a put.
A and D
Which of the following statements is FALSE? A. The price at which the holder buys or sells the share of stock when the option is exercised is called the strike price or exercise price. B. When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed−upon price, he is exercising the option. C. There are two kinds of options. European options allow their holders to exercise the option on any date up to and including a final date called the expiration date. Your answer is correct. D. Because an option is a contract between two parties, for every owner of a financial option there is also an option writer, the person who takes the other side of the contract.
C. There are two kinds of options. European options allow their holders to exercise the option on any date up to and including a final date called the expiration date. Your answer is correct.
Using options to reduce risk is called: A. speculation. B. a naked position. C. hedging. D. a covered position.
C. hedging.
As the seller of an option, you are guaranteed to receive the: A. exercise price. B. strike price. C. option premium. D. risk premium.
C. option premium.
Which of the following will NOT increase the value of a put option? A. An increase in the exercise price B. A decrease in the stock price C. A decrease in the stock's volatility D. An increase in the time to maturity
C. A decrease in the stock's volatility
Which of the following statements is FALSE? A. The intrinsic value of an option is the value it would have if it expired immediately. B. Put options increase in value as the stock price falls. C. A put option cannot be worth more than its strike price. D. A European option cannot be worth less than its American counterpart.
D. A European option cannot be worth less than its American counterpart.
option buyer (holder)
Holds the right to exercise the option and has a LONG position in the contract
option writer
The seller of an option contract
You happen to be checking the newspaper and notice an arbitrage opportunity. The current stock price of Intrawest is $15per share and the one-year risk-free interest rate is 7%. A one-year put on Intrawest with a strike price of $11 sells for $5.06,while the identical call sells for $10.09. Intrawest doesn't pay any dividends. Explain what you must do to exploit this arbitrage opportunity.
The strategy would be to sell the call option, buy the put and the stock, and borrow $10.28. The net benefit is $0.31.
open interest
The total number of outstanding contracts of a particular option that have been written
Why do people write options?
When you. sell an option, you get paid for it - options always have positive prices
Financial Option
a contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price at some future date
Deep in/out of the money
describes options where the strike price and the stock price are very far apart
When the holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price, he is
exercising the option
stock option
gives the holder the option to buy or sell a share of stock on or before a given date for a given price
call option
gives the owner the right to BUY the asset
put option
gives the owner the right to SELL the asset
out-of-the-money
if the payoff from exercising an option immediately is negative
in-the-money
if the payoff from exercising an option immediately is positive
strike price (exercise price)
the price at which the holder buys or sells the share. of stock when the option is exercised
option premium
the price you pay to buy an option
at-the-money
when the exercise price of an option is equal to the current stock price, the option is at-the-money
What is the difference between an European option and an American option? Are European options available exclusively in Europe and American options available exclusively in the United States? A. European options can be exercised only on the exercise date and are exclusively available in Europe, while American options can be exercised on any date prior to the exercise date and are exclusively available in America. B. European options can be exercised only on the exercise date, while American options can be exercised on any date prior to the exercise date. Both types of options are traded in Europe and in America. C. The only difference between the European option and the American option is that the European options are only available in Europe, and the American options are exclusively available in America. D. American options can be exercised only on the exercise date, while European options can be exercised on any date prior to the exercise date. Both types of options are traded in Europe and in America.
B. European options can be exercised only on the exercise date, while American options can be exercised on any date prior to the exercise date. Both types of options are traded in Europe and in America.
Explain why an American call option on a non-dividend-paying stock always has the same price as its European counterpart.
Because the option to exercise early is worthless, the American option provides no more benefits than its European counterpart.
Explain the difference between a long position in a put and a short position in a call. A. When a party has a long position in a put, it has the obligation to sell the underlying asset at the strike price; when it has a short position in a call, it has the obligation to buy the underlying asset at the strike price if exercised. B. When a party has a long position in a put, it has the obligation to buy the underlying asset at the strike price; when it has a short position in a call, it has the right to sell the underlying asset at the strike price if exercised. C. When a party has a long position in a put, it has the right to sell the underlying asset at the strike price; when it has a short position in a call, it has the right to buy the underlying asset at the strike price if exercised. D. When a party has a long position in a put, it has the right to sell the underlying asset at the strike price; when it has a short position in a call, it has the obligation to sell the underlying asset at the strike price if exercised.
D. When a party has a long position in a put, it has the right to sell the underlying asset at the strike price; when it has a short position in a call, it has the obligation to sell the underlying asset at the strike price if exercised.
An option strategy in which you hold a long position in both a put and a call option with the same strike price iscalled: A. a butterfly spread. B. portfolio insurance. C. a strangle. D. a straddle.
D. a straddle.
A credit default swap is essentially a: A. call option on the firm's assets. B. put option on the firm's debt. C. call option on the firm's debt. D. put option on the firm's assets.
D. put option on the firm's assets.
Wesley Corp. stock is trading for $35 per share. Wesley has 25 million shares outstanding and a market debt-equity ratio of 0.62. Wesley's debt is zero-coupon debt with a 5-year maturity and a yield to maturity of 9%. a. Describe Wesley's equity as a call option. What is the maturity of the call option? What is the market value of the asset underlying this call option? What is the strike price of this call option? b. Describe Wesley's debt using a call option. c. Describe Wesley's debt using a put option.
a. The maturity is 5 years. Total assets is equal to equity plus debt. Therefore, Assets=$35 per share×25 million shares+0.62×($35 per share×25 million shares)=$1,417.50 million The market value of the asset underlying this call option is $1,417.50 million. The strike price is equal to the face value of the debt. Therefore, Face Value of Debt=0.62×($35 per share×25 million shares)×(1+0.09)5=$834.70 million The strike price of this call option is $834.70 million. b. Buy the firm's assets and short the equity call option with a strike price equal to $834.70 million. c. Long risk-free debt with a 5-yr maturity and $834.70 million face value and short a put option on Wesley's assets with a 5-yr maturity and a strike of $834.70 million
Suppose Amazon stock is trading for $2020 per share, and Amazon pays no dividends. a. What is the maximum possible price of a call option on Amazon? b. What is the maximum possible price of a put option on Amazon with a strike price of $2080? c. What is the minimum possible value of a call option on Amazon stock with a strike price of $2000? d. What is the minimum possible value of an American put option on Amazon stock with a strike price of $2080?
a. The maximum possible price of the call option on Amazon would be $2020 b. The maximum possible price of a put option on Amazon would be $2080 c. The minimum possible value of the call option on Amazon stock would be $20 d. The minimum possible value of the American put option on Amazon stock would be $60
American Option
can be exercised on or before its expiration
European option
can be exercised only at expiration
