A study on call_and_put_options

Jun 28th, 2015
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A. T. Still University
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A call option is a financial contract between two parties, the buyer and the seller of this type of option. Often it is simply labeled a "call". The buyer of the option has the right but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time for a certain price (the strike price). The seller (or "writer") is obliged to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.

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Option ARMOption ARMs are scary because monthly payments can stay low for a long time and then suddenly go kerflooey. (Did I spell kerflooey right?)Standard & Poor's is out today with a press release about a report that explains why they tightened up their criteria for option ARMs, effective Aug 1. The report (which is available under Ratings Criteria on the S&P website, fifth item down) explains why S&P felt it necessary to assume higher foreclosure frequencies on option ARMs.With an option ARM, you have the option to make a minimum payment that doesn't even cover all the interest you owe, let alone any of the principal. The unpaid interest gets added to the balance on the loan. Annual caps on how much your payment can go up--typically 7.5%--give a false sense of security. The caps are like keeping your thumb over the mouth of a bottle while vigorously shaking it. Eventually, if you underpay what you owe for long enough, the principal on your loan will breach a preset limit, which tends to be either 10% or 25% greater than the original amount borrowed. At that point, all caps are blown off and the monthly payment jumps all the way up to whatever is required to fully amortize the loan over its remaining life.Example given by S&P: The monthly payment goes up between month 48 and month 49 by 88%. On a $500,000 loan, using S&P's assumptions and my multiplying skills from fifth grade, that would be as follows:Month 1: $1,665Month 48: $2,070Month 49: $3,900"Payment sh

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