Jinky Naduma

BSBA-3C

Chapter Requirement on Using Options as Investments:

1. What is an investment option?

 Investment Option means an investment fund, index or vehicle selected by the

Committee and made available to Participants for the deemed investment of their
Accounts.

2. Define:

Option Buyer - An Option Buyer is someone who buys an option from sellers/ writer.
The buyer of an option pays a premium and buys the right of that particular option but is
not obliged to writer to exercise the option.

Option Writer - Option writers collect a premium in exchange for giving the buyer the
right to buy or sell the underlying at an agreed price within an agreed period of time.

European Options - A European option is a version of an options contract that limits

execution to its expiration date. In other words, if the underlying security such as a stock
has moved in price an investor would not be able to exercise the option early and take
delivery of or sell the shares. 

American Options - An American option is a version of an options contract that allows

holders to exercise the option rights at any time before and including the day of
expiration.

Define the following key terms:

* American options

• "At the money“ - An equity call or put option is at-the-money when its strike price is
the same as the current underlying stock price.

• Black-Scholes model - A pricing model that is based on factors that include the strike
price, the price of the underlying security, the length of time until expiration, and
volatility. Read about the Black Scholes Pricing Model

• Call option - An equity option that gives its buyer the right to buy 100 shares of the
underlying stock at the strike price per share at any time before it expires. The call seller
(or writer), on the other hand, has the obligation to sell 100 shares at the strike price if
called upon to do so.

• European options - A European option is a version of an options contract that limits

execution to its expiration date.

• Exercise price (strike price) - A term of any equity option contract, it is the price per
share at which shares of stock will change hands after an option is exercised or
assigned. Also referred to as the “strike price,” or simply the “strike.”

• Expiration date - The day on which an option contract literally expires and ceases to
exist. For equity options, this is the Saturday following the third Friday of the expiration
month. The last day on which expiring equity options trade and may be exercised is the
business day prior to the expiration date, or generally the third Friday of the month.

• "In the money“ - An equity call contract is in-the-money when its strike price is less
than the current underlying stock price. An equity put contract is in-the-money when its
strike price is greater than the current underlying stock price.

• Intrinsic value of option - The in-the-money portion (if any) of a call or put contract’s
current market price.

• Hedger - An investment technique used to reduce the risk of holding a specific

investment. Options are commonly used as hedging tools: protecting another's existing
position or a position in another financial instrument such as stock.

• Hedging - Hedging is a strategy that tries to limit risks in financial assets.

• Hedge ratio - The hedge ratio compares the amount of a position that is hedged to the
entire position.

• Option - An option is a contract that gives a buyer the right to buy or sell shares of the
underlying asset at a predetermined price called the strike price within a certain period
of time.

• Option buyer - An Option Buyer is someone who buys an option from sellers/ writer.
The buyer of an option pays a premium and buys the right of that particular option but is
not obliged to writer to exercise the option.

• Option premium - Option premium will consist of extrinsic, or time value for out-of-
the-money contracts and both intrinsic and extrinsic value for in-the-money options.
• Option writer - Option writers collect a premium in exchange for giving the buyer the
right to buy or sell the underlying at an agreed price within an agreed period of time.

• "Out of money“ - An equity call option is out-of-the-money when its strike price is
greater than the current underlying stock price. An equity put option is out-of-the-money
when its strike price is less than the current underlying stock price.

• Riskless (perfect) hedge - A perfect hedge is a position undertaken by an investor

that would eliminate the risk of an existing position, or a position that eliminates all
market risk from a portfolio. In order to be a perfect hedge, a position would need to
have a 100% inverse correlation to the initial position.

• Perfect hedge ratio - The optimal hedge ratio or minimum variance hedge ratio is a
concept that defines the degree of correlation between an asset or liability and the
financial product (normally a futures contract) purchased to hedge financial risks.

• Put option - A put option is an option contract giving the owner the right, but not the
obligation, to sell a specified amount of an underlying security at a specified price within
a specified time. This is the opposite of a call option, which gives the holder the right to
buy shares.

• Profit or loss on option - Options contracts and strategies using them have defined
profit and loss—P&L—profiles for understanding how much money you stand to make
or lose. Depending on the options strategy employed, an individual stands to profit from
any number of market conditions from bull and bear to sideways markets.

• Straddle - A straddle refers to an options strategy where the investor holds a position
in both call and puts with the same strike price and expiration. The idea is to capitalize
in a strong move in either direction. You can have both a long straddle and a short
straddle position.

• Time value - For a call or put, it is the portion of the option’s premium (price) that
exceeds its intrinsic value (in-the-money amount), if it has any. By definition, the
premium of at- and out-of-the-money options consists only of time value. It is time value
that is affected by time decay as well as changing volatility, interest rates and dividends.

• Underlying security - The stock on which a specific equity option’s value is based,
which changes hands when the option is exercised or assigned.