Questions and Answers
What does a Delta value closer to 0 indicate about an option?
What is the primary factor that increases Vega for an option?
Which option greek measures the sensitivity of option value due to changes in interest rates?
When is the Theta of an option expected to be lower?
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What determines the intrinsic value of a European Call option when it is at the money?
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For which type of option is the maximum value directly equal to the exercise price at expiration?
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What does a buyer of a Long Put hope for regarding the stock price and the exercise price?
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How does gamma behave as an option approaches expiration?
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What investment strategy is characterized by buying two calls and one put?
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What is the significance of time value in options trading?
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In a situation where a put option is overpriced in the market, what action should an investor take?
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What is the main characteristic of a Protective Put strategy?
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Which option best describes a Covered Call strategy?
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In a Strip option strategy, an investor expects which market condition?
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What is the correct relationship between the values of call options and the maximum of the spot price minus the present value of the exercise price and dividends?
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Why are American puts generally valued higher than European puts?
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How does high volatility affect the value of both call and put options?
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What is the main reason for exercising American options before the dividend payout date?
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In a covered call strategy, what is required for every call option written?
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What is the primary purpose of a protective put strategy?
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What determines the maximum value of an American put option at expiration?
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How does the time to expiration affect the value of options?
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Which statement regarding the relationship between exercise prices and option values is true for call options?
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What is the relationship between the exercise price of put options and their premiums?
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When considering dividends, what impact do they have on the intrinsic value of call options?
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What characterizes the difference between American and European options at expiration?
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What is the effect on the premiums of call options when comparing options with different exercise prices?
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In regards to put options, which of the following statements is true?
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When comparing the differences in exercise prices and option prices, what is the result for put options?
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Study Notes
Options Trading
- Long Put: The buyer has the right to sell, hoping the price will go down.
- Short Call: The seller has the right to sell, hoping the price will go up.
- Long Call: The buyer has the right to buy, hoping the price will go up.
- Short Put: The seller is obliged to buy if the buyer exercises the option, hoping the price will go up.
Profit Strategies
- Underpriced Call: Buy a call option and sell the stock to profit from the difference.
- Overpriced Put: Sell a put option and sell shares to profit from the higher price.
- Underpriced Put: Buy a put option and buy shares to profit from the lower price.
- Overpriced Call: Sell a call option and buy shares to profit from the lower price.
Options Strategies
- Straddle: Buy a call and put option with the same exercise price and expiration date.
- Protective Put: Buy a put option and buy shares to limit potential losses.
- Covered Call: Sell a call option and buy shares to profit from the premium.
- Strap: Buy two calls and one put option, hoping the stock price will go up.
- Strip: Buy two puts and one call option, hoping the stock price will go down.
Greeks
- Delta: Measures the change in option value due to a change in the stock price.
- Gamma: Measures the change in delta due to a change in the stock price.
- Vega: Measures the change in option value due to a change in volatility.
- Rho: Measures the change in option value due to a change in the risk-free rate.
- Theta: Measures the change in option value due to a change in time to expiration.
Option Boundaries
- Minimum Value: The minimum value of an option is 0.
- Maximum Value: The maximum value of a call option is the stock price, and the maximum value of a put option is the exercise price.
Time to Expiration
- Call Option: The longer the time to expiration, the more expensive the option.
- Put Option: The longer the time to expiration, the more expensive the option.
Exercise Price
- Call Option: A lower exercise price increases the value of the option.
- Put Option: A higher exercise price increases the value of the option.
Premiums
- Call Option: The premium depends on the exercise price, spot price, volatility, time to expiration, and interest rates.
- Put Option: The premium depends on the exercise price, spot price, volatility, time to expiration, and interest rates.
Dividends
- Call Option: A dividend payment decreases the value of the option.
- Put Option: A dividend payment increases the value of the option.
Early Exercise
- Call Option: American call options can be exercised before expiration, but it's only worthwhile if there are dividends.
- Put Option: American put options can be exercised before expiration, but it's only worthwhile if the stock price is low.
Interest Rates
- Call Option: Higher interest rates increase the value of the option.
- Put Option: Higher interest rates decrease the value of the option.
Volatility
- Call Option: Higher volatility increases the value of the option.
- Put Option: Higher volatility increases the value of the option.
Profit Equations
- Call Option: Profit = Nc [Max (0, St - X) - C]
- Put Option: Profit = Np [Max (0, X - St) - P]
Trading Strategies
- Bullish Strategy: Buy a stock, take a call, or write a put.
- Bearish Strategy: Short a stock, write a call, or take a put.
- Covered Call: Sell a call option and buy shares to profit from the premium.
- Protective Put: Buy a put option and buy shares to limit potential losses.### Protective Put
- A protective put involves buying a stock and a put option to protect against potential losses if the stock price falls.
- The put option allows the holder to sell the stock at the exercise price, limiting potential losses.
- Profit is calculated as: Exercise Price - Price paid for Stock - Premium paid for Put Option (if stock price is below exercise price).
- Minimum value of the protective put is the exercise price.
Bull Spread
- A bull spread is a strategy used to limit potential losses and gains by buying and selling call options with different exercise prices.
- The purpose is to benefit from a potential increase in stock price while limiting potential losses.
- A bull spread involves buying a call option with a lower exercise price (X1) and selling a call option with a higher exercise price (X2).
- Profit equation: Intrinsic Value of Buying Call - Price Paid for option - Intrinsic Value of selling call + Premium Received for selling.
Bear Spread (Using Calls)
- A bear spread using calls is a strategy used to benefit from a potential decrease in stock price while limiting potential losses.
- The purpose is to speculate on a falling stock price while limiting potential losses.
- A bear spread involves buying a call option with a higher exercise price (X2) and selling a call option with a lower exercise price (X1).
- For a long position, X2 is higher, and for a short position, X1 is lower.
Bear Spread (Using Puts)
- A bear spread using puts is a strategy used to benefit from a potential decrease in stock price while limiting potential losses.
- The purpose is to speculate on a falling stock price while limiting potential losses.
- A bear spread involves buying a put option with a higher exercise price (X2) and selling a put option with a lower exercise price (X1).
- Maximum profit: Exercise Price (X2) - Exercise Price (X1) + Premium received (P1) - Premium paid (P2).
- Minimum profit: Premium received (P1) - Premium paid (P2).
Straddle
- A straddle is a strategy used to take advantage of an expected market movement without knowing the direction.
- A straddle involves buying an equal number of puts and calls with the same exercise price.
- Maximum profit: Infinite.
- Minimum profit: Premium of Call - Premium of Put.
- The straddle allows the holder to profit from a movement in either direction, as one option will be in the money.
Straps
- A strap is a strategy used to double up on a bet that the stock price will increase.
- A strap involves buying two long calls and one long put.
- Maximum profit: Infinite.
- Minimum profit: Lower, as the holder needs to pay double for the call options.
Strips
- A strip is a strategy used to double up on a bet that the stock price will decrease.
- A strip involves buying two long puts and one long call.
- Maximum profit: Infinite.
- Minimum profit: 2 x Price of Put - Price of Call.
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Description
Explore the fundamentals of options trading through this quiz. Test your understanding of concepts such as Long Put, Short Call, Long Call, and Short Put. Understand the hopes and obligations of option takers and writers.
