[Q&A] options
Q: tell me about options.
A: options are financial derivatives that give the option buyer the right to buy or sell at a specific price within a specified period. Call option gives the right to buy, put option gives the right to sell. The specific price is "exercise price" or "strike price".
options have 3 money conditions, for call options:
(1) at the money: current stock price=strike price
(2) in the money: current stock price>strike price
(3) out of the money: current stock price<strike price
Q: what people do if they believe the underlying stock price will go up?
A: buy a call option or write a put option.
Q: what's the difference between American option and standard European option?
A: American option can be executed before the expiration date; European option can't.
Q: tell me about factors affecting option value.
A: option's intrinsic value is the max(0, strike price-current stock price)
- price of underlying assets: for call option, the higher the underlying stock's price, the higher the option value. Put option the opposite.
- strike price: for call option, the higher the strike price, the lower the option value. Put option the opposite.
- variance of returns on underlying assets: for both call and put, the higher the volatility of the underlying assets, the higher the option value.
- time to expiration/maturity: the more time the holder has to exercise the option, the higher the option value.
- riskless interest rate: for call option, the higher interest rate leads to a lower strike price (discount to PV) and makes the option more valuable. Put option the opposite.
- PV of dividends: a higher dividend means the expected capital gain of the stock will be lower, and the potential increase in stock price will be lower too. So larger dividend payouts lower the call option value. Put option the opposite.
Q: tell me about option greeks.
A:
- delta: option price change v.s. price change of the underlying stock
- gamma: option price change v.s. change in delta; option gamma is also called convexity.
- theta: the rate of decline in the value of an option due to the passage of time [time decay]
- vega: option price change v.s. underlying assets volatility
- rho: option price change v.s. interest rate change
Q: tell me about the Black-Scholes model.
A: options are financial derivatives that give the option buyer the right to buy or sell at a specific price within a specified period. Call option gives the right to buy, put option gives the right to sell. The specific price is "exercise price" or "strike price".
options have 3 money conditions, for call options:
(1) at the money: current stock price=strike price
(2) in the money: current stock price>strike price
(3) out of the money: current stock price<strike price
Q: what people do if they believe the underlying stock price will go up?
A: buy a call option or write a put option.
Q: what's the difference between American option and standard European option?
A: American option can be executed before the expiration date; European option can't.
Q: tell me about factors affecting option value.
A: option's intrinsic value is the max(0, strike price-current stock price)
- price of underlying assets: for call option, the higher the underlying stock's price, the higher the option value. Put option the opposite.
- strike price: for call option, the higher the strike price, the lower the option value. Put option the opposite.
- variance of returns on underlying assets: for both call and put, the higher the volatility of the underlying assets, the higher the option value.
- time to expiration/maturity: the more time the holder has to exercise the option, the higher the option value.
- riskless interest rate: for call option, the higher interest rate leads to a lower strike price (discount to PV) and makes the option more valuable. Put option the opposite.
- PV of dividends: a higher dividend means the expected capital gain of the stock will be lower, and the potential increase in stock price will be lower too. So larger dividend payouts lower the call option value. Put option the opposite.
Q: tell me about option greeks.
A:
- delta: option price change v.s. price change of the underlying stock
- gamma: option price change v.s. change in delta; option gamma is also called convexity.
- theta: the rate of decline in the value of an option due to the passage of time [time decay]
- vega: option price change v.s. underlying assets volatility
- rho: option price change v.s. interest rate change
Q: tell me about the Black-Scholes model.
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