Re: Derivatives

[Abhishek]

Hi geetha, 

Q-1 : When u write a call you are short the stock, theoretically the stock's market value can become infinite so your loss also will be infinite. This is the answer

Buying a call : The max loss that I can suffer when i buy any option is the option premium. If the position is unfavourable for me at expiration, i will not exercise the options

When you write or SELL a put option, you have basically long position in stock. The max loss or risk you can suffer is when the stock value becomes 0. This is less risky that writing or selling calls.

Q-2 :: Covered call is covered in the class, writing covered calls is when you SELL the call option on the stock that you ALREADY own. People do this because they believe that the stock price will be stable (Not up or down) in the near future and they want to increase there profit by earning the premium that they will get when they Write or SELL the call option.

I am writing the payoff of one option here, you try writing the payoff of other options i.e. b and c

A) Covered call and a short stock combined with a long call. 

Covered call is SHORT CALL and LONG STOCK so the payoff for this portfolio will be -(negative) The payoff of call which is Max [0, S-x] + (positive) S and combine this with LONG CALL implies +  Max [0, S-x]. So net payoff is just from the stock OR S as Short call in covered call and long call will cancel each other. 

Trying writing the payoffs for other two. 

Q3) Consider the put option on NASDAQ 100 selling for $106.25 in which
the Excercise price is $2100. Determine the value at expiration & the
profit for a seller when underlying at expiration is $2150. Formula -
max(0,X-S)+P, advise why a minus sign is used for max & explain the
value for a put writer? [CFA material, pg 177, sum 3B]

Premium is something that the option holder will get irrespective of any market movement = 106.25$

Now he has shorted the put so his payoff will be negative the payoff of put which is Max[0, X-S]

X=2100, S = 2150. The put payoff is Max of 0 or 2100-2150 which is 0 i.e. the option buyer will not exercise the option. So the option or put seller will not pay anything so all he gains is the premium. 

Which Negative sign are we talking about ??? 

Trust this helps

Rgds,

Abhishek

On Fri, Feb 12, 2010 at 2:12 PM, Geetha Vramani <vramani...@gmail.com> wrote:

Hi Ratan,

Please advise on the following questions -
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Q1) Which of the following is the riskiest single-option transaction?
(Please explain how a covered call effects this answer )

a. Writing a call
b. Buying a call
c. Writing a put

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Q2) Which of the following combinations & underlying investments have
similarly shaped profit/loss diagrams? A:

a. covered call and a short stock combined with a long call.
b. short put option combined with a long call option and a protective
put.
c. long call option combined with a short put position and a long
stock position.

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Q3) Consider the put option on NASDAQ 100 selling for $106.25 in which
the Excercise price is $2100. Determine the value at expiration & the
profit for a seller when underlying at expiration is $2150. Formula -
max(0,X-S)+P, advise why a minus sign is used for max & explain the
value for a put writer? [CFA material, pg 177, sum 3B]

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Thanks,
Geetha

--
Regards,
Abhishek Dhall
Product Management | Global Marketing
Headstrong, Bangalore
abhishe...@headstrong.com