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3.
Why do you think exchanges are more concerned with naked option writers
than covered option writers?
Covered option writers have own the security that have agreed to sell or
already sold short the securities they have agreed to buy. Naked options
writers do not own an offsetting security position. Therefore they need to
deposit margin requirements with the exchange to guarantee their promise.
Additional questions:
1. Why does a lower strike price imply that a call option will have a higher premium
and a put option a lower premium?
Because for any given price at expiration, a lower strike price means a higher profit
for a call option and a lower profit for a put option. A lower strike price makes a call
option more desirable and raises its premium and makes a put option less desirable
and lowers its premium.
2. Explain how foreign exchange derivatives could be used by U.S. speculators to
speculate on the expected appreciation of the Japanese yen.
U.S. Speculators could attempt to lock in an exchange rate at which they could
exchange dollars for yen at a future point in time. This could be accomplished by
purchasing forward contracts or future contracts on Japanese yen, negotiating a swap
for swap for yen, or purchasing yen call option. They could also sell yen put options
to capitalize on their expectation.
3. What are some considerations in the decision to use options for hedging?
Gains and losses in futures contracts are virtually without limit. For that reason, some hedgers
prefer options. Options give a one-sided type of price protection that is not available from
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futures. However, premium on options may be high, and the value of options decays over
time . The buyer of protection must decide whether the insurance value provided by the
option is worth the price.
4. If you buy a put option on a $100,000 Treasury bond future contract with an
exercise price of $95 and the price of the Treasury bond is $120 at expiration, is
the contract in the money, out of the money, or at the money? What is your profit
or loss on the contract if the premium was $4,0000?
5. Explain why greater volatility or a longer term to maturity leads to higher
premium on both call and put options.
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