Financial Risk Management, which is covered in Chap. 17 of the ETM 2nd Ed (or Chapt. 9 of the ETM 3rd Ed.), is a subject that many of you have probably not had a lot of exposure to in your professional careers. I think this is especially true regarding the area of this chapter that introduces the use of options to hedge financial risk and the “trading floor lingo” associated with this activity like ”In-and- Out-of the-Money,” etc. ,etc. So, here’s a little Options-ese/English translation and some ideas for remembering what these terms mean in case you get an exam question that uses this specialized language.
Call or Put Options: Asset Price equals Strike Price
Call Option: Asset Price less than Strike Price “CALL LESS”
Put Option: Asset Price more than Strike Price “PUT MORE”
Call Option: Asset Price more than Strike Price “CALL MORE”
Put Option: Asset Price less than Strike Price “PUT LESS”
Also, you could be asked an exam question where you need to use your knowledge of “Options-ese” to determine if the Asset Price/Exercise Price relationship for a given option contract is at a gain or a loss. Here are three rules you can use for this type of question.
1) Out-of-the-Money Call and Put options are not exercised which results in a LOSS equal to the cost of the premium.
“LOSS when CALL or PUT is OUT”
2) In-the Money Call option results in a GAIN that is equal to: Asset Price less Exercise Price less Premium
“GAIN when CALL is IN”
3) In-the Money Put option results in a GAIN that is equal to: Exercise Price less Asset Price less Premium
“GAIN when PUT is IN”
- George Schilling, CTP