Page 107 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes Short Put: A short put is simply the sale of a put option.
Straddle: In finance, a straddle is an investment strategy involving the purchase or sale of
particular option derivatives that allows the holder to profit based on the magnitude of price
movement in the underlying security, regardless of the direction of price movement.
Strips: Strips as an option trading strategy is used when the investor is expecting that there
would be big price change in the stock price as a result of which the prices would relatively
decrease more than increase, thus effecting a bearish trend.

7.7 Review Questions

1. What is an option strategy? Explain the significance of choosing a right option strategy.

2. List and explain the four basic kinds of option trades used by an investor for hedging
purposes.
3. 'Long call and short put are strategies for the bullish market'. Explain this statement.

4. Draw the differences between long call and short put in the light of the profit/loss position
at expiration of the option contracts.
5. What is a Covered Call? Why it is so called? Using a example, state the maximum profit
and maximum loss out of covered call position.
6. When is a Protective Put as an option strategy used by investors? Is this similar to having
a long position in Call Option?
7. What is an Option Spread? Distinguish between vertical option spread and horizontal
option spread.
8. When is a Bull Spread used for hedging? What is the cost involved in talking a position in
bull spread?

9. List and explain the salient features of a C all Bull spread. Explain the profit/loss position
at expiration for call bull spread.
10. Discuss the basic types of pay-offs with suitable figures.

Answers: Self Assessment

1. False 2. False

3. True 4. True
5. False 6. True
7. "writing" 8. Naked calls
9. bear 10. credit

11. long straddle 12. premium
13. box spread 14. condor spread
15. False 16. False

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