Options Pricing: Black-Scholes Model. How to Read an Options Chain - Trading Markets. There are two ways for speculators to bet on a decline in the value of an upt buying put options or short selling. This is, then, a bull or debit call spread. There was an error.




In the Series 7 exam, questions about options tend to be one of the biggest challenges for test takers. This is because options questions make up a large part of the exam and many candidates have never been exposed to options contracts and strategies. In this article we'll give you a call and put option formulas to remember description of the world of options contracts remembet well as the strategies associated with them.

Our test-taking tips will put you in a position to ace this portion of the Series 7 exam and increase your chances of getting a passing score. For everything you need to know for the Series 7 exam, see our Free Series 7 Online Study Guide. By most estimates, there are about 50 questions on options on the Series 7 exam, approximately 35 of which are questions that deal with options strategies. The remaining 15 questions anv options markets, rules and suitability questions.

Because most of the questions rmeember on options strategies, we'll concentrate on those. It Takes Two to Make a Contract Remember the word contract. There are two parties in a contract. When one party gains a dollar, the other party loses a dollar. For that reason, the buyer and the seller reach the breakeven point at the same time.

When the buyer has regained all of the premium money spent, the seller has lost the entire premium they received. This situation is called a zero-sum game : for every person who gains on a contract, there is a counterparty that loses. Most Options Contracts Are Not Exercised The majority of options investors are not interested in buying or selling stock. They are interested in profits from trading the contracts themselves. In one sense, the options exchanges are much like horse racing tracks.

While there are people there who plan to buy or sell a horse, most of the crowd is there to bet on the race. Pay very close attention to the concepts of opening and closing options contract positions and don't be locked into the idea of exercising contracts. Terminology Tangles Notice in Figure 1 — which we'll call the "matrix" — that the term "buy" can be replaced by the terms " long " or " hold.

Write the matrix down on your scratch paper before starting the exam and refer to it frequently to help keep you on track. Buyers' Rights, Sellers' Obligations If you look at Figure 1, you'll notice that buyers have all the rights; they've paid a premium for the rights. Sellers have all the obligations; they've received a call and put option formulas to remember for taking the obligation risk. You can think of an options contract like a car insurance contract: the buyer pays the premium and has the right to exercise; they can lose no more than the premium paid.

The opton has the obligation to perform when and if called upon by the buyer; the most the seller can gain is the premium received. Apply these ideas to options contracts. Question "Call Up and Put Down" Many people have been misled by the old saying "call up and put down. It's true for the buy or long side, but it is not true of the sell side. On the short, or sell side, things are exactly opposite in that you could profit from an increase in the asset underlying a put option if you have shorted a put.

Time Value forex web based trading platform 14 Buyers and Sellers Because an option has a definite expiration date, the time value of the contract is often called a wasting asset. Remember: buyers always want the contract to be exercisable. They may never exercise they will probably sell the contract — closing call and put option formulas to remember — for a profit insteadbut they want to tormulas able to exercise.

Sellers, on the other hand, want the contract to expire worthless because this is the only way that the seller short can keep the entire premium the maximum call and put option formulas to remember to sellers. One of the problems that Series 7 candidates report when working on options problems, is that they are not sure of how to approach the questions. There is a four-step process that is usually helpful: All four of these steps may not be necessary for each and every options problem.

If, however, you use the process in the more complex situations, you'll find that these steps greatly simplify the problem. Question: An investor is long 1 XYZ December 40 call at 3. Just prior to the close of the market on the final trading day before expiration, XYZ stock is trading at The investor closes the contract. What is the gain or loss to the investor? Answer: Questions in the exam may refer to a situation in which a contract is "trading on its intrinsic value.

Because the investor is long the contract, they have paid a premium. The problem states that the investor closes the position. If an options investor buys to close the position, the investor will sell the contractoffsetting the open long position. This investor will sell the contract for its intrinsic value because there is no time value remaining. How can you arrive at the intrinsic value so easily?

Look at Figure 2, the intrinsic value chart. If the contract is a call and the market is above the strike exercise pricethe contract is in the money — it has an intrinsic value. Put contracts operate in exactly the opposite direction. One cautionary note: the contract itself is in or out of the money, but this does not necessarily translate into a profit or loss for a particular investor. Buyers want the contracts to be in the money have an intrinsic value.

Sellers want contracts to be out of the money no intrinsic value. Refer again to Figure 1 and remember that whenever the buyer gains a dollar, the seller loses a dollar. Call buyers are bullish; call sellers are bearish. Look at the call and put option formulas to remember simply swap the gains and losses and remember that both parties to the contract break even at the same point.

Note that in Figure 1, the buyers of puts are bearish. The market value of the underlying stock must drop below the strike price go in the money enough to recover the premium for the contract holder buyer, long. The maximum gains and losses are expressed as dollars. So to find that amount, we multiply the breakeven price by Questions regarding straddles on the Series 7 tend to be limited in scope.

Primarily they focus on straddle strategies and the fact that there are always two breakeven points. Steps 1 and 2: The first item on your agenda when you see any multiple options strategy on the exam is to identify the strategy. This is where the matrix in Figure 1 becomes a useful tool. If an investor, for example, is buying a call and a put on the same stock with the same expiration and the same strike, the strategy is a straddle. Look back at Figure 1. If you look at buying a call and buying a put, an imaginary loop around those positions is a straddle — in fact, it is a long straddle.

If the investor is selling a call and selling a put on the same stock with the same expiration and the same strike price, it is a short straddle. If you look closely at the arrows within the loop on the long straddle in Figure 1, you'll notice that the arrows are moving away from each other. This is a reminder that the investor who has a long straddle expects volatility. Look now at the arrows within the loop on the short straddle; they are coming together.

This is a reminder that the short straddle investor expects little or no movement. These are the essential straddle strategies. Step 3 and 4: By looking at the long or short position on the matrix, you've completed the second part of the four-part process. Because you are using the matrix for the initial identification, skip to step four. In a straddle, investors are either buying two contracts or selling two contracts.

To find the breakeven, add the two premiums and then add the total of the premiums to the strike price for the breakeven on the call contract side. Subtract the total from the strike price for the breakeven on the put contract side. A ane always has two breakevens. Let's look at an example. An investor buys 1 XYZ November 50 call 4 and is long 1 XYZ November 50 put 3.

At what points will the investor break even? Hint: once you've identified a straddle, write the two contracts out on your scratch paper with the call contract above the put contract. This makes the process easier to visualize. Instead of clearly asking for the two breakeven points, the question may ask: between what two prices will the investor have a loss? If you're dealing with a long straddle, the investor must hit the breakeven acll to recover the premium. Movement above or below the breakeven point will be profit.

Notice that the xall in the problem illustrated above match the arrows within the loop for a long straddle. The investor in a long straddle is expecting volatility. Note: because the investor in a long straddle expects volatility, the maximum optlon would occur if the stock price were to be exactly the same as the strike price at the money — neither contract would have any intrinsic value. Of course, opiton investor with a short straddle would like the market price to close at the money to keep all the premiums.

In a short straddle, everything is reversed. If asked, the calculation of the breakevens is the same, and the same general strategies — volatility or no movement — apply. Spread strategies seem to be the most difficult for many Series 7 candidates. By using the tools we have already discussed and some acronyms that will help in remembering different spread objectives, we'll simplify spreads.

Identify the Strategy: A spread is defined as an investor being long and short the same type of options contracts dj fx trader k or puts with differing expirations, strike prices or both. If only the strike prices are different, it is a price or vertical spread. If only the expirations are different, it is a calendar spread also known as a "time" or fo spread.

If both the strike price and expirations are different, it is a diagonal spread. All of these terms refer to the layout of options quotes in the newspapers. The strategy laid out above is a call spread. Technically, it is a vertical call spread. Identify the Position : In spread strategies, the investor is a buyer or a seller. When you determine the position, look at the block in the matrix that illustrates that position and keep your attention on that block alone.

At this point, we need to address the idea of debit versus credit. If the investor has paid out more than they have received, it is a debit DR spread. If the investor has received more in premiums than they have paid out, it is a credit CR spread. These terms are critical to answering spread questions. Here, there is one additional qualifier to the complete description of the spread. We can now call it a debit call spread. The investor is, puh net terms, a buyer of call contracts.

Look at the matrix: buyers of calls are bullish. This is, then, a bull or debit call spread. The investor is anticipating a rising market in the stock. Check the Matrix: Actually, we could have used the matrix to identify the strategy as nad spread. If you look at the matrix and see that the two positions are inside the horizontal loop on the matrix, the strategy is caall spread. That way, the buying side of the matrix will be directly above the DR and the selling side of the matrix will be exactly above the CR side.

Tip: notice that in the example, the higher strike price is written above the lower strike price. Once you've identified a spread, write the two contracts on your kption paper with the higher formuas price above the lower strike price. This makes it much easier to visualize the movement of the underlying stock between the strike prices. The maximum gain for the buyer; loss for the seller and the breakeven for both will always be between the strike prices.

Tip: For optjon, an acronym some candidates find helpful is CAL — In a C all spread A dd the net premium to the L ower strike price. Tip: above 60, the investor has no gain or loss. Remember when an investor sells or writes an option, they are obligated. This investor has the right to purchase at 50 and ane obligation to deliver at Be very careful to remember the rights and obligations when solving spread problems. There are other, very frequently reported questions about spreads.

Referring tk to the example: Tip: The first point of call and put option formulas to remember is this: in any question of this nature regarding spreads, the answer will always be widen or narrow. Eliminate C and D. Once you've identified the strategy as a spread and identified the position as a debitthe investor expects the difference between the premiums to widen. Remember: buyers want to be able to exercise. Sellers, those in a credit position, want the contracts to expire valueless no intrinsic value, worthless and the spread in pug to narrow.

Tip: for breakevens, an acronym some call and put option formulas to remember find helpful is PSH — In a P ut spread S ubtract the net premium from the H igher strike anf. Spreads may require more steps for a solution, but if you use the shortcuts, solving the problem is much simpler. Options contracts questions in the Series 7 exam are numerous, but the scope of the questions is limited. If you use the four-step process, you can dramatically increase your chances of getting a passing score.

To get the hang of it, you'll have to practice as many questions on options as possible before remejber taking the exam. Term Of The Day A regulation implemented on Jan. Tour Legendary Investor Jack Fkrmulas Office. Louise Yamada on Evolution of Technical Analysis. Financial Advisors Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education.

Tips For Series 7 Options Questions. By Investopedia Staff Call and put option formulas to remember February 3, — AM EST. In the Series 7 exam, questions about options strategies concentrate on:. However, the scope of the questions tends to be limited to:. Four No-Fail Steps to Follow. There is a four-step process that is usually helpful:.

Use the matrix to verify desired movement. All four of these steps may not be necessary for each and every options problem. Let's use the four steps outlined above in some examples. The first formula a Series 7 candidate should remember is for fodmulas options premium:. First, let's use the four-step process:. Identify the strategy — A call contract. Use the matrix to verify desired movement — bullish, wants the market to rise.

Follow the dollars — Make a list of dollars remfmber out:. Related Articles Knowing which option spread strategy to use in different market conditions can significantly improve your odds of success in options trading. A bull call spread is an option strategy that involves the purchase of a call option, and the simultaneous sale of another option on the same underlying asset with the same expiration date We show why regional language options computer xps options on the Dow Jones is a good alternative to remebmer the exchange-traded fund.

Being both short and long has advantages. Find out how to straddle a position to your advantage. A bull call optiln, also called a vertical spread, involves buying a call option at a specific strike price and simultaneously selling another call option at a higher strike price. We tell you about four option strategies that could provide a way to pay off your debt. This trading strategy is an excellent limited-risk strategy that can be used with equity as well as commodity and futures options. With options, the direction of a stock's next major move becomes less important than its magnitude.

Learn about debit and credit option spread strategies, how these strategies are used, and the differences between debit spreads Hot Definitions Opption regulation implemented on Jan. A supposition that explains teletrade israeli relationship between principals and agents in business. Agency theory is concerned with resolving A short-term debt obligation backed by the U.

T-bills are sold in denominations A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical Return on market value of equity ROME is a comparative measure typically used by analysts to identify companies that generate The majority shareholder is often the founder No thanks, I prefer not making money.




Calculating gains and losses on Call and Put option transactions


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