How to solve Options basics questions
Put-call parity, spread and straddle payoffs, the at-the-money rule of thumb, time value and delta hedging. Rates are zero unless the question says otherwise.
How to solve them
Parity
- Cue: you know one of call, put or stock and need another at the same strike.
- Method: C - P = S - PV(K). With zero rates PV(K) = K.
- Memory hook: long call + short put = long forward.
- Check: an in-the-money call is worth more than the matching put.
- Interviewers often follow up with "what if rates were 5%?" or "what happens if vol doubles?". Have the direction ready.
Payoffs
- Cue: spreads, straddles, butterflies, "breakeven", "max profit".
- Method: draw the payoff at expiry at each strike, then subtract what you paid.
- Call spread max = width - cost. Fly max = wing width - cost. Straddle breakevens = K +/- total premium.
- Interviewers often follow up with "what if rates were 5%?" or "what happens if vol doubles?". Have the direction ready.
Atm
- Cue: "roughly", "at the money", vol and time given.
- Method: ATM option = 0.4 x S x vol x sqrt(T).
- Anchors: sqrt(1/4) = 0.5, sqrt(1/12) = 0.29, sqrt(1/52) = 0.14.
- Check: doubling vol doubles the price, quadrupling time doubles it.
- Interviewers often follow up with "what if rates were 5%?" or "what happens if vol doubles?". Have the direction ready.
Value
- Cue: "intrinsic" or "time value".
- Method: intrinsic = max(S - K, 0) for a call, max(K - S, 0) for a put. Time value is the rest of the price.
- Check: time value is largest at the money.
- Interviewers often follow up with "what if rates were 5%?" or "what happens if vol doubles?". Have the direction ready.
Delta
- Cue: "delta neutral", "hedge".
- Method: shares of exposure = contracts x 100 x delta. Trade the opposite in stock.
- Long calls and short puts have positive delta. Short calls and long puts have negative delta.
- Interviewers often follow up with "what if rates were 5%?" or "what happens if vol doubles?". Have the direction ready.
Worked examples
Stock at 105. The 100-strike call trades at 6. How much of the price is time value? Answer to 2 decimals.
Answer: 1
- Intrinsic value = max(S - K, 0) = max(105 - 100, 0) = 5.
- Time value = 6 - 5 = 1.00.
Stock at 107, rates zero. The 102-strike call is 11.00. What is the 102-strike put worth? Answer to 2 decimals.
Answer: 6
- Put-call parity: C - P = S - K.
- P = C - S + K = 11.00 - 107 + 102.
- P = 6.00.
You buy the 80 straddle: the call for 2 and the put for 6. What is the upper breakeven at expiry? Answer to 2 decimals.
Answer: 88
- Total premium = 2 + 6 = 8.
- The stock has to finish 8 away from 80: 88.
Firms that test this
Akuna Capital · SIG · IMC · Jane Street