Description
- Explain call and put options. Show your own examples about how to calculate their payoff (Long call, short call, long put, and short put).
- Show your own example about daily marking-to-market of futures contract. Include a margin call.
- Show your own example about a plain vanilla interest rate swap using fixed and floating rates (Libor).
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Question One
Call and put options
Call and put options are financial assets called derivatives since the value is dependent upon the
value of the underlying asset, in which case the outcome of the contract is related to the value of
the relevant instrument (HR Stoll (1969).
Call Option
A call option grants the holder has the chance to purchase the stock of the option at the exercise
price on or before the due date. For example, a single purchase option agreement may authorize a
holder to purchase one hundred shares of XYZ stock for $100 till the date of expiry of three
months. Traders have many expiration dates and strike prices to choose from. As the xyz shares
increases, the price of an option contract will rise, and vice versa. The buyer of the call option
can maintain the contract till the date of expiry, at which point he can receive 100 shares or sell
the option contract at any time before the due date.
The M.P of a call option is referred to as a premium. This is the price paid for the rights
offered by the call option. If the underlying asset is below the strike price at maturity, the
notified buyer will lose the premium paid. This is the biggest loss. If the underlying value/price
is more than the strike price at maturity, the return is equivalent to the current price of the stock
minus the strike price and premium. This is multiplied by the value of shares under the control of
the option buyer.
For example, if the XYZ quote is $110, the strike price is $100, the option cost is $2 for
the buyer, and the yield is $110 - ($100 + $2) = $8. If the buyer purchases a contract equivalent
to $800 (8 x 100 shares), or if he buys two contracts (8 x $200), he buys $1,600.
Finance Questions
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If XYZ is less than $100 at maturity, the value lost by the buyer would be $200 (2 x 100 shares)
for the contracts he bought.
Long Call
The long call option strategy is the most basic option trading strategy. The option holder
purchases the option and belie...
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