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4 Jan 2018

Identify and describe the fundamental distinctions between a futures contract and an option contract, and briefly explain the difference in the manner that futures and options modify portfolio risk.

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Irving Heathcote
Irving HeathcoteLv2
5 Jan 2018

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1. Options versus Futures Describe the general differences between a call option and a futures contract.

2. Speculating with Call Options How are call options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a call option?

3. Speculating with Put Options How are put options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a put option?

4. Selling Options Under what conditions would speculators sell a call option? What is the risk to speculators who sell put options?

7. Leverage of Options How can financial institutions with stock portfolios use stock options when they expect stock prices to rise substantially but do not yet have sufficient funds to purchase more stock?

8. Hedging with Put Options Why would a finan- cial institution holding the stock of Hinton Co. consider buying a put option on that stock rather than simply selling it?

9. Call Options on Futures Describe a call option on interest rate futures. How does it differ from purchasing a futures contract?

10. Put Options on Futures Describe a put option on interest rate futures. How does it differ from selling a futures contract?

11. Hedging Interest Rate Risk Assume a savings institution has a large amount of fixed-rate mortgages and obtains most of its funds from short-term deposits. How could it use options on financial futures to hedge its exposure to interest rate movements? Would futures or options on futures be more appropriate if the institution is concerned that interest rates will decline, causing a large number of mortgage prepayments?

14. Speculating with Stock Options The price of Garner stock is $40. There is a call option on Garner stock that is at the money with a premium of $2.00. There is a put option on Garner stock that is at the money with a premium of $1.80. Why would investors consider writing this call option and this put option? Why would some investors consider buying this call option and this put option?

1. Options versus Futures Describe the general differences between a call option and a futures contract.

2. Speculating with Call Options How are call options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a call option?

3. Speculating with Put Options How are put options used by speculators? Describe the conditions under which their strategy would backfire. What is the maximum loss that could occur for a purchaser of a put option?

4. Selling Options Under what conditions would speculators sell a call option? What is the risk to speculators who sell put options?

7. Leverage of Options How can financial institutions with stock portfolios use stock options when they expect stock prices to rise substantially but do not yet have sufficient funds to purchase more stock?

8. Hedging with Put Options Why would a finan- cial institution holding the stock of Hinton Co. consider buying a put option on that stock rather than simply selling it?

9. Call Options on Futures Describe a call option on interest rate futures. How does it differ from purchasing a futures contract?

10. Put Options on Futures Describe a put option on interest rate futures. How does it differ from selling a futures contract?

11. Hedging Interest Rate Risk Assume a savings institution has a large amount of fixed-rate mortgages and obtains most of its funds from short-term deposits. How could it use options on financial futures to hedge its exposure to interest rate movements? Would futures or options on futures be more appropriate if the institution is concerned that interest rates will decline, causing a large number of mortgage prepayments?

14. Speculating with Stock Options The price of Garner stock is $40. There is a call option on Garner stock that is at the money with a premium of $2.00. There is a put option on Garner stock that is at the money with a premium of $1.80. Why would investors consider writing this call option and this put option? Why would some investors consider buying this call option and this put option?

1. A put option on gold is struck at $1237. What happens if you exercise when the futures price is $1209 and the futures contract settles at $1211?

2. The futures price of gold is $1237. A put and a call on this gold futures contract, both struck at $1215 both sell for $10. The interest rate is 2 percent. The options both expire in one year, and both are European. Identify an arbitrage opportunity.

3. The June Natural Gas Futures price is $3.336/mmBTU. A call on June NG struck at $3.40 is currently selling at $.149, and a put struck at $3.40 is selling at $.203. These prices are quoted as of 5 April. The option expires on 29 May, 2017. The relevant interest rate is 1.0 percent. The options are European. Identify an arbitrage opportunity. Indicate which option you should buy, which option you should sell, and whether you should buy or sell the futures contract.

4. If the options are American, is there still an arbitrage opportunity? If so, indicate the transactions you should undertake (what to buy, what to sell).

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