Essay about Call Option and Intrinsic Value

Submitted By mlongo2727
Words: 908
Pages: 4

Chapter 1: Derivative: a contract between two parties providing for a payoff from one party to the other determined by the price of an asset, an exchange rate, a commodity price, or an interest rate. Derivative product is defined as financial contracts with settlement depending on the outcome of the underlying assets in the future. Advantages of OTC: terms can be tailored to specific needs of the parties, private market in which no one needs to know about the transactions, unregulated. Disadvantages of OTC: credit risk is higher, transaction size larger than what normal investors can handle. Chapter 8:Forward vs. Futures: definition: a contract between a buyer and a seller to purchase or sell something (the underlying) at a later date (maturity date) at a price (called forward/futures price) agreed upon today. Forward: unregulated, OTC traded, larger bet each contract, $84T mkt size, margin account usually required. Future: regulated and exchange traded margin account always required. Arbitrageurs attempt to profit from differences in the prices of otherwise identical spot and futures positions. Two rules: do not take any risk do not spend any money. Hedging: A) Long in the “underlying” → when the underlying price goes up, you will be happy, but sad when the price decreases. B) Short in the “underlying” → when the underlying price decreases, you will be happy, but sad when the price goes up. IF current position is type (a), sell forward/futures contracts to hedge. IF current position is type (b), buy forward/futures contracts to hedge. Ways to exit forward/futures contract: submit offsetting trade before or on last trading day. et your contract expire and wait for final settlement right after maturity date. For contracts with cash settlement: last trading date is the settlement date for contracts with delivery settlement: last trading date is the position date. Exchange for Physicals (EFP): the only type of permissible futures transaction that occurs off the floor of the exchange the holders of long and short positions get together and agree on a cash transaction that would close out their futures position. EFP market simply gives parties additional flexibility in making delivery, choosing the terms, and conducting such business when the exchanges are closed. Chapter 2:Call: the holder has the right to buy a specific amount (contract size) of the “underlying” at the predetermined “strike price” on (European Style) or before-or-on the maturity day (American Style). Put: the holder has the right to sell a specific amount (contract size) of the “underlying” at the predetermined “strike price” on (European Style) or before-or-on the maturity day (American Style). A bullish trader can choose to buy a call or short a put. A bearish trader can choose to buy a put or short a call. if your current position is long in the underlying, buy put options to hedge. If your current position is short in the underlying, buy call options to hedge. You cannot hedge by shorting options! Pro’s of hedging with options: Flexibility and profit potential. Chapter 3: Important five factors: S0 current stock price, X Exercise Price, r the applicable risk free rate applied during the duration of the option, St stock price at expiration, T length to maturity. S0 has a POSITIVE effect on CALL value, but a NEGATIVE effect on PUT value. X has a NEGATIVE effect on CALL, but a POSITIVE effect on PUT. R has a positive effect on CALL value, but a NEGATIVE effect on PUT. T always has a non-negative effect on American options,…