Options Trading: Long and Short Positions

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Questions and Answers

What is the primary hope of someone who takes a Long Call option?

The price of the stock is equal to the exercise price.

The price of the exercise option is less than the stock price. (correct)

The stock price will decrease significantly.

The price of the stock is lower than the exercise price.

What does the seller of a Short Put option hope for in the market?

The stock price will exceed the exercise price. (correct)

The stock price will rise drastically.

The market will remain volatile.

The stock price will fall below the exercise price.

In which scenario would you consider executing a Short Call strategy?

You expect the stock price to remain stable.

You believe the option is undervalued.

You anticipate a bearish market condition. (correct)

The market is expected to rise significantly.

What defines a Straddle option strategy?

Buying both a call and put option at the same exercise price. Signup and view all the answers

Which profit strategy involves selling the option when its price is perceived to be inflated?

Shorting an overpriced put. Signup and view all the answers

What is the investment focus of a Protective Put strategy?

A bullish outlook combined with stock ownership. Signup and view all the answers

Which scenario best describes a Strap option strategy?

Buying two calls and one put, anticipating an uptrend. Signup and view all the answers

What do you generally expect when you take a Long Put position?

The stock price will decrease below the exercise price. Signup and view all the answers

How does one profit from an underpriced call option?

By buying the underpriced call and then selling the stock. Signup and view all the answers

What is a key assumption behind the strategy of a Covered Call?

The market is anticipated to decline. Signup and view all the answers

What is the likely impact on the overall delta of a portfolio consisting of two puts and one call?

The delta will be highly negative, indicating a high likelihood of the options expiring out of the money Signup and view all the answers

What is the formula for calculating delta?

Delta = Change in option value / small change in stock price Signup and view all the answers

What is the relationship between gamma and the option's proximity to expiration?

Gamma increases as the option approaches expiration Signup and view all the answers

What is the formula for calculating vega?

Vega = Change in option value / change in implied volatility Signup and view all the answers

When is vega at its highest value?

When the option is at the money Signup and view all the answers

What is the relationship between theta and the time to expiration?

Theta increases as the time to expiration increases Signup and view all the answers

What is the formula for calculating rho?

Rho = Change in option value / change in risk-free rate Signup and view all the answers

What is the relationship between delta and the option's moneyness?

Delta is highest when the option is deep in the money Signup and view all the answers

What is the relationship between gamma and the option's moneyness?

Gamma is highest when the option is at the money Signup and view all the answers

What is the formula for calculating theta?

Theta = Change in option value / change in time to expiration Signup and view all the answers

Study Notes

Option Trading Strategies

A Long Put gives the buyer the right to sell, hoping the strike price (X) is higher than the spot price (So).
A Short Call gives the seller the obligation to sell, hoping the strike price (X) is higher than the spot price (So).
A Long Call gives the buyer the right to buy, hoping the spot price (So) is higher than the strike price (X).
A Short Put gives the seller the obligation to buy, hoping the spot price (So) is higher than the strike price (X).

Profiting from Underpriced or Overpriced Options

To profit from an underpriced Call, buy the call and sell the stock.
To profit from an overpriced Put, sell the put and sell shares.
To profit from an underpriced Put, buy the put and buy shares.
To profit from an overpriced Call, sell the call and buy shares.

Option Trading Terminology

A Straddle involves buying a call and put option with the same exercise price and time to expiration.
A Protective Put involves buying a put and buying shares, with a bullish market outlook.
A Covered Call involves selling a call and buying shares, with a bearish market outlook.
A Strap involves buying two calls and one put, with a bullish market outlook.
A Strip involves buying two puts and one call, with a bearish market outlook.

The Greeks

The Greeks measure the sensitivity of an option's value to various factors.
Delta measures the change in option value due to a small change in stock price.
Delta = Change in option value / small change in stock price.
Delta ranges from 0 (out of the money) to 1 (in the money).

Gamma

Gamma measures the sensitivity of Delta to movements in the stock price.
A higher gamma means the option value is more affected by stock price movements.
Gamma is highest when the option is "at the money" and closer to expiration.

Vega

Vega measures the sensitivity of the option value to changes in volatility.
Vega = Change in Option Value / Change in Implied Volatility (standard deviation).
Vega is highest when the option is "at the money".

Rho

Rho measures the sensitivity of the option value to changes in the risk-free rate.
Rho = Changes in option value / change in risk-free rate.

Theta

Theta measures the sensitivity of the option value to changes in time to expiration.
Theta = changes in options value / changes in time to expiration.
Theta is higher for longer times to expiration and lower for shorter times to expiration.

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Description

Quiz on options trading, covering long and short positions, including calls and puts, and the buyer's and seller's hopes.