OK class, it’s time to go over the options quiz that you took last week. We had good participation, and I sent CBOE hats to winners in California, Colorado, New Jersey, Illinois and the United Kingdom.
1) I work 7 days a week. I’m like a sculptor chipping away at time premium every day. When my deadline is getting closer, I work faster and faster to get my job done. Who am I?
Mostly everyone got this one right. The answer of course is Theta, which is the change in an options theoretical value for every one-unit change in time which is usually a day. The closer an option gets to expiration, the decay of time premium increases at an accelerated rate.
2) When volatility changes, I don’t, but I can change the price of an option. At-the-money I am the biggest and I only affect timepremium. But as time goes by there is less and less of me. Who am I?
This is the one almost everybody got wrong except our “star students”. Volatility is probably the most misunderstood option concept. Vega is the correct answer here. Vega is the change in an options theoretical value for every one-point change in volatility. It is constant over a wide range of volatility. Vega is the biggest at-the-money because that’s where the most time premium is. And remember, volatility only affects time premium. Vega gets smaller as time goes by.
3) Some people say I look like I am walking like an Egyptian. I am not a Bangle but I am a trade and I look just like this:
Who am I?
This is the risk profile of a Bull Call Spread or Bull Put Spread which are synthetically the same. With both strategies, the most you can make is the difference in the strike prices less the premium paid. And the most you can lose is what you paid for the spread.
So that’s it. I hope you had fun taking the challenge. Thank you all again for playing! Peter