Investment Analysis and Options in Practice

These flashcards cover key concepts in investment analysis and options, providing definitions crucial for understanding options trading and pricing.

Option

Gives the holder the right to buy/sell a specified quantity of a certain product at a predetermined strike price at a specified future expiration date.

Call Option

An option that gives the holder the right to buy the underlying asset at a specified strike price.

Put Option

An option that gives the holder the right to sell the underlying asset at a specified strike price.

Long (holder/buyer)

The party who has bought the option.

Short (writer/seller)

The party who has sold or written the option.

Option Premium

The payment made by the holder to the writer at the time of signing the option contract.

Strike Price (K or X)

The predetermined price at which the underlying asset can be bought or sold.

Expiration Date (T)

The date on which the option contract becomes void.

Risk-Free Rate (rf)

The theoretical return on an investment with zero risk, typically represented by government treasury yields.

Intrinsic Value (IV)

The value of an option if it were exercised today; calculated as max(0; St - K) for calls and max(0; K - St) for puts.

Time Value (TV)

The portion of an option's premium that exceeds its intrinsic value, representing the potential for further price movement before expiration.

In-the-Money (ITM)

A situation where exercising the option would be profitable; for a call, this is when St > K.

At-the-Money (ATM)

A situation where the strike price of an option is equal to the market price of the underlying asset.

Out-of-the-Money (OTM)

A situation where exercising an option would not be profitable; for a call, this is when St < K.

Put-Call Parity

The relationship between the price of European call and put options of the same class, implying that the price of calls and puts should result in the same profit if a stock is priced higher or lower.

Binomial Option Pricing Model

A mathematical model used to price options by simulating different paths an asset's price could take over time.

Payoff Function

A graph that shows the profits or losses from an option based on the underlying asset's price at expiration.