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    Part 1. Definition of Terms: Saplad, Mark Risen S. 11/14/2020 Bsba FMGT 3-A Prof. Adolf Josef Yao

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    Mark Risen Saplad
    The document defines key terms related to options such as call options, exercise price, premium, put options, in the money, out of the money, at the money, American and European options, protective put, covered call, straddle, spread, collar, put-call parity theorem, and warrant. It then provides examples of risk-increasing and risk-reducing options strategies and discusses the trade-offs of buying put options or writing call options on an existing portfolio. Finally, it calculates the payoff and profit for various call and put options on IBM stock assuming the stock price reaches $150 on expiration date.

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    Part 1. Definition of Terms: Saplad, Mark Risen S. 11/14/2020 Bsba FMGT 3-A Prof. Adolf Josef Yao

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    Mark Risen Saplad
    48 views3 pages
    The document defines key terms related to options such as call options, exercise price, premium, put options, in the money, out of the money, at the money, American and European options, protective put, covered call, straddle, spread, collar, put-call parity theorem, and warrant. It then provides examples of risk-increasing and risk-reducing options strategies and discusses the trade-offs of buying put options or writing call options on an existing portfolio. Finally, it calculates the payoff and profit for various call and put options on IBM stock assuming the stock price reaches $150 on expiration date.

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    The document defines key terms related to options such as call options, exercise price, premium, put options, in the money, out of the money, at the money, American and European options, protective put, covered call, straddle, spread, collar, put-call parity theorem, and warrant. It then provides examples of risk-increasing and risk-reducing options strategies and discusses the trade-offs of buying put options or writing call options on an existing portfolio. Finally, it calculates the payoff and profit for various call and put options on IBM stock assuming the stock price reaches $150 on expiration date.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    48 views3 pages

    Part 1. Definition of Terms: Saplad, Mark Risen S. 11/14/2020 Bsba FMGT 3-A Prof. Adolf Josef Yao

    Uploaded by

    Mark Risen Saplad
    The document defines key terms related to options such as call options, exercise price, premium, put options, in the money, out of the money, at the money, American and European options, protective put, covered call, straddle, spread, collar, put-call parity theorem, and warrant. It then provides examples of risk-increasing and risk-reducing options strategies and discusses the trade-offs of buying put options or writing call options on an existing portfolio. Finally, it calculates the payoff and profit for various call and put options on IBM stock assuming the stock price reaches $150 on expiration date.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
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    of 3

    Saplad, Mark Risen S.

    11/14/2020
    BSBA FMGT 3-A Prof. Adolf Josef Yao

    Part 1. Definition of terms

    ●Call option gives the right to purchase a security at the exercise price on or before an
    expiration date.
    ●Exercise price refers to the price set for calling (buying) an asset or putting (selling)
    an asset.
    ●Premium is the purchase price of an option.
    ●Put option is the right to sell an asset at a specified exercise price on or before a
    specified expiration date.
    ●In the money describes an option whose exercise would produce a positive cash flow.
    ●Out of the money describes an option where exercise would result in a negative cash
    flow.
    ●At the money refers to the option’s exercise price and the price of the underlying
    asset are equal.
    ●American option can be exercised before and up to its expiration date.
    ●European option can be exercised only on the expiration date.
    ●Protective put refers to the purchasing of an asset combined with a put option on that
    asset to guarantee proceeds at least equal to the put’s exercise price.
    ●Covered call is a combination of selling a call option together with buying the
    underlying asset.
    ●Straddle is a combination of buying both a call and a put on the same asset, each with
    the same exercise price and expiration date. The purpose is to profit from expected
    volatility.
    ●Spread is a combination of two or more call or put options on the same stock with
    differing exercise prices or times expiration.
    ●Collar is an option strategy that brackets the value of a portfolio between two bonds.
    ●Put-call parity theorem is an equation representing the proper relation between put
    and call prices. Violation of parity implies the existence of arbitrage opportunities.
    ●Warrant is an option issued by the firm to purchase shares of the firm’s stock.
    Part 2. Problem set 

    1. We said that options can be used either to scale up or reduce overall portfolio risk. What are
    some examples of risk-increasing and risk-reducing options strategies? Explain each. 
    Risk-increasing options strategy 
     American Option because it is more expensive due to traders taking more risks. Since
    American-style option sellers are taking on more risk, they charge a higher risk
    premium when they sell their options—which raises the price of the option.
     Covered call because it carries unlimited risk as opposed to a naked put where the
    maximum loss occurs if the stocks falls to zero.
     Short straddle is dangerous because potential loss is unlimited if the stock price
    rises and substantial if the stock price falls.
     
    Risk-reducing options strategy 
     Collar option because it limits downside risk and a conservative strategy to protect the
    profits.
     Protective Put because it allows the traders to hold their stock while protecting it against
    the loses. It also allows quickly transform into Synthetic Straddle in order to profit from up
    and down moves.
     Warrants generally offer a long-term investing and tend to be high risk but have a high
    reward investment. When it is exercised, company issues new shares and increase the total
    number of outstanding shares.
     
    2. What are the trade-offs facing an investor who is considering buying a put option on an
    existing 
    portfolio?  
    Purchasing put option gives an insurance and protection to avoid portfolio's decreasing
    value. An investor who believes trade-off (higher risk with higher return) may face the value of
    their put option against reducing its cost. Protective put may help them to protect their profit
    against losses during a price decline and allowing for capital appreciation if the stock increases
    in value.

    3. What are the trade-offs facing an investor who is considering writing a call option on an
    existing portfolio? 
    An investor deals with covered call on a stock that they can sacrifice all the upside
    movement past the strike price while retaining all of the downside only if the volatility is less than
    expected and the stock price does not move at all does writing call options give them excess
    returns.

    4. Why do you think the most actively traded options tend to be the ones that are near
    the money?
    Traders tend to use options that are near the money because of trade-offs. It is applied
    for obtaining highest potential gain because of highest time premium so that they will have the
    highest volume and gain more profits.
    5. Turn back to Figure 20.1, which lists prices of various IBM options. Use the data in the
    figure to calculate the payoff and the profits for investments in each of the following July
    expiration options, assuming that the stock price on the expiration date is $150. 
     
    Formula: Call option 
    Value at expiration = Stock price - Exercise price  
    Profit/Loss = Final Value – Original Investment 
     
    Formula: Put option 
    Value at expiration = Exercise price – Stock price 
    Profit/Loss = Final Value – Original Investment 
     
    a. Call option, X = $145. 
    Answer: 
    Value at Expiration/Payoff = $150 - $145= $5/share 
    Profit/Loss = $5.00 - $5.18= - $0.18 
     
    b. Put option, X = $145. 
    Answer: 
    Value at Expiration= $145 - $150= -$5/share 
    Profit/Loss= - $5.00 - $0.48= - $5.48 
     
    c. Call option, X = $150. 
    Answer:  
    Value at Expiration= $150 - $150= $0/share 
    Profit/Loss= $0 -$1.85= - $1.85 
     
    d. Put option, X = $150. 
    Answer: 
    Value at Expiration=$150 - $150= $0/share 
    Profit/Loss= $0 - $1.81= - $1.81 
     
    e. Call option, X = $155. 
    Answer: 
    Value at Expiration=$150 - $155= - $5/share 
    Profit/Loss= - $5.00 – $0.79= - $5.79 
     
    f. Put option, X = $155. 
    Answer: 
    Value at Expiration=$155 - $150= $5/share 
    Profit/Loss= $5.00 - $5.95= - $0.95 
     

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