Deck 20: Understanding Options

Question 1

Figure 3 depicts the

A)position diagram for the writer (seller)of a call option.
B)profit diagram for the writer (seller)of a call option.
C)position diagram for the writer (seller)of a put option.
D)profit diagram for the writer (seller)of a put option.

Answer 1

profit diagram for the writer (seller)of a put option.

Question 2

The writer (seller)of a regular exchange-listed call-option on a stock

A)has the right to buy 100 shares of the underlying stock at the exercise price.
B)has the right to sell 100 shares of the underlying stock at the exercise price.
C)has the obligation to buy 100 shares of the underlying stock at the exercise price.
D)has the obligation to sell 100 shares of the underlying stock at the exercise price.

Answer 2

has the obligation to sell 100 shares of the underlying stock at the exercise price.

Question 3

The writer (seller)of a regular exchange-listed put-option on a stock

A)has the right to buy 100 shares of the underlying stock at the exercise price.
B)has the right to sell 100 shares of the underlying stock at the exercise price.
C)has the obligation to buy 100 shares of the underlying stock at the exercise price.
D)has the obligation to sell 100 shares of the underlying stock at the exercise price.

Answer 3

has the obligation to buy 100 shares of the underlying stock at the exercise price.

Question 4

The following are examples of "disguised options":
I.acquiring growth opportunities;
II.ability of the firm to terminate a project when it is no longer profitable;
III.covenants within corporate securities that provide flexibility to change the terms of the securities

A)I only
B)II only
C)I and III only
D)I, II, and III

Question 5

The buyer of a call option has the right to exercise the option, but the writer of the call option has the

A)choice to offset with a put option upon exercise.
B)obligation to deliver the shares at the exercise price.
C)choice to deliver shares or take a cash payoff.
D)obligation to deliver a put option upon exercise.

Question 6

A put option gives the owner the right

A)and the obligation to buy an asset at a given price.
B)and the obligation to sell an asset at a given price.
C)but not the obligation to buy an asset at a given price.
D)but not the obligation to sell an asset at a given price.

Question 7

In June 2020, an investor buys call options on Amgen stock with an exercise of price of $65 and expiring in January 2022. If the stock price in June 2021 is $60, then these options are
I.in-the-money;
II.out-of-the-money;
III.a LEAPS option

A)I only
B)II only
C)III only
D)II and III only

Question 8

The two principal options exchanges in the United States are the:
I.International Securities Exchange;
II.New York Stock Exchange;
III.NASDAQ;
IV.Chicago Board of Options Exchange

A)II and III only
B)I and II only
C)I and IV only
D)III and IV only

Question 9

From a geometric viewpoint, how is the position diagram for a put option related to the diagram of a call option on the same stock having the same exercise price and maturity?

A)The inverse of the call diagram
B)Unrelated to the call diagram no matter what the exercise price
C)The mirror image of the call diagram, reflected around the exercise price
D)Exactly the same as the call diagram for the given exercise price

Question 10

An option that can be exercised any time before its expiration date is called:

A)a European option.
B)an American option.
C)a call option.
D)a put option.

Question 11

An investor, in practice, can buy
I.an option on a single share of stock
II.blocks of 100 options

A)I only
B)II only
C)Both I and II
D)None of the options.

Question 12

The value of a put option at expiration equals the

A)market price of the share minus the exercise price.
B)higher of the exercise price minus market price of the share and zero.
C)exercise price.
D)share price.

Question 13

Figure 1 depicts the

A)position diagram for the buyer of a call option.
B)profit diagram for the buyer of a call option.
C)position diagram for the buyer of a put option.
D)profit diagram for the buyer of a put option.

Question 14

Suppose an investor sells (writes)a put option. What will happen if the stock price on the exercise date exceeds the exercise price?

A)The seller will need to deliver stock to the owner of the option.
B)The seller will be obliged to buy stock from the owner of the option.
C)The owner will not exercise the option.
D)The option will extend for nine more months.

Question 15

The owner of a regular exchange-listed put-option on a stock

A)has the right to buy 100 shares of the underlying stock at the exercise price.
B)has the right to sell 100 shares of the underlying stock at the exercise price.
C)has the obligation to buy 100 shares of the underlying stock at the exercise price.
D)has the obligation to sell 100 shares of the underlying stock at the exercise price.

Question 16

In June 2020, an investor buys a put option on Genentech stock with an exercise price of $75 and expiring in January 2022. If the stock price in July 2020 is $80, then this option is
I.in-the-money
II.out-of-the-money
III.a LEAPS option

A)I only
B)II only
C)III only
D)II and III only

Question 17

The owner of a regular exchange-listed call-option on a stock

A)has the right to buy 100 shares of the underlying stock at the exercise price.
B)has the right to sell 100 shares of the underlying stock at the exercise price.
C)has the obligation to buy 100 shares of the underlying stock at the exercise price.
D)has the obligation to sell 100 shares of the underlying stock at the exercise price.

Question 18

Figure 2 depicts the

A)position diagram for the buyer of a call option.
B)profit diagram for the buyer of a call option.
C)position diagram for the buyer of a put option.
D)profit diagram for the buyer of a put option.

Question 19

Firms regularly use the following to reduce risk:
I.currency options
II.interest-rate options
III.commodity options

A)I only
B)II only
C)III only
D)I, II, and III

Question 20

Figure 4 depicts the

A)position diagram for the writer (seller)of a call option.
B)profit diagram for the writer (seller)of a call option.
C)position diagram for the writer (seller)of a put option.
D)profit diagram for the writer (seller)of a put option.

Question 21

If the stock makes a dividend payment before the expiration date, then the put-call parity relation is

A)Value of call = value of put + share price − present value (PV)of dividend − PV of exercise price.
B)Value of call = value of put − share price + PV of dividend − PV of exercise price.
C)Value of call = value of put + share price + PV of dividend + PV of exercise price.
D)Value of call = value of put + share price + PV of dividend − PV of exercise price.

Question 22

All else equal, as the underlying stock price increases:

A)the call price decreases.
B)the call price increases.
C)there is no effect on call price.
D)the call price can either increase, decrease, or remain the same.

Question 23

Buying the stock and the put option on the stock provides the same payoff as

A)investing the present value of the exercise price in T-bills and buying the call option on the stock.
B)short-selling the stock and buying a call option on the stock.
C)writing (selling)a put option and buying a call option on the stock.
D)a T-bill.

Question 24

Suppose the underlying stock pays a dividend before the expiration of options on that stock. This will:
I.increase the value of a call option;
II.increase the value of a put option;
III.decrease the value of a call option;
IV.decrease the value of a put option

A)I and II only
B)III and IV only
C)I and IV only
D)II and III only

Question 25

If the volatility of the underlying asset decreases, then the

A)value of the put option will increase, but the value of the call option will decrease.
B)value of the put option will decrease, but the value of the call option will increase.
C)value of both the put and call option will increase.
D)value of both the put and call option will decrease.

Question 26

Relative to the underlying stock, a call option always has

A)a higher beta and a higher standard deviation of return.
B)a lower beta and a higher standard deviation of return.
C)a higher beta and a lower standard deviation of return.
D)a lower beta and a lower standard deviation of return.

Question 27

A call option has an exercise price of $150. At the option expiration date, the stock price could be either $100 or $200. Which investment would combine to give the same payoff as the stock?

A)Lend PV of $100 and buy two calls.
B)Lend PV of $100 and sell two calls.
C)Borrow $100 and buy two calls.
D)Borrow $100 and sell two calls.

Question 28

Suppose an investor buys one share of stock and a put option on the stock and simultaneously sells a call option on the stock with the same exercise price. What will be the value of his investment on the final exercise date?

A)Above the exercise price if the stock price rises and below the exercise price if it falls
B)Equal to the exercise price regardless of the stock price
C)Equal to zero regardless of the stock price
D)Below the exercise price if the stock price rises and above if it falls

Question 29

Which of the following investors would be happy to see the stock price rise sharply?
I.An investor who owns the stock and a put option;
II.An investor who has sold a put option and bought a call option;
III.correct for projects that have average risk compared to the firm's other assets. An investor who owns the stock and has sold a call option
IV.An investor who has sold a call option

A)I and II only
B)III and IV only
C)III only
D)IV only

Question 30

All else equal, as the underlying stock price increases:

A)the put price increases.
B)the put price decreases.
C)there is no effect on put price.
D)the put price can either increase, decrease, or remain the same.

Question 31

For European options, the value of a call minus the value of a put is equal to

A)the present value of the exercise price minus the value of a share.
B)the present value of the exercise price plus the value of a share.
C)the value of a share plus the present value of the exercise price.
D)the value of a share minus the present value of the exercise price.

Question 32

Buying a call option, investing the present value of the exercise price in T-bills, and short-selling the underlying share is the same as

A)buying a call and a put.
B)buying a put and a share.
C)buying a put.
D)selling a call.

Question 33

For European options, the value of a call plus the present value of the exercise price is equal to

A)the value of a put minus the value of a share.
B)the value of a share minus the value of a call.
C)the value of a put plus the value of a share.
D)the value of a share minus the value of a put.

Question 34

Consider the following data for a European option: Expiration = 6 months; Stock price = $80; Exercise price = $75; Call option price = $12; Risk-free rate = 5 percent per year. Using put-call parity, calculate the price of a put option having the same exercise price and expiration date.

A)$3.07
B)$5.19
C)$11.43
D)$3.42

Question 35

Put-call parity can be used to show

A)how valuable in-the-money put options can get.
B)how valuable in-the-money call options can get.
C)the precise relationship between put and call option prices, given equal exercise prices and equal expiration dates.
D)that the value of a call option is always twice that of a put, given equal exercise prices and equal expiration dates.

Question 36

Suppose you buy a call and lend the present value of its exercise price. You could match the payoffs of this strategy by

A)buying the underlying stock and selling a call.
B)selling a put and lending the present value of the exercise price.
C)buying the underlying stock and buying a put.
D)buying the underlying stock and selling a put.

Question 37

Which of the following features increase(s)the value of a call option?
I.A high interest rate;
II.A long time to maturity;
III.A higher volatility of the underlying stock price

A)I only
B)II only
C)III only
D)I, II, and III

Question 38

For European options, the value of a put is equal to

A)the value of a call minus the value of a share plus the present value of the exercise price.
B)the value of a call plus the value of a share plus the present value of the exercise price.
C)the value of the share minus the value of a call plus the present value of the exercise price.
D)the value of the share minus the present value of the exercise price plus the value of a call.

Question 39

If the risk-free interest rate increases, then

A)call option prices increase.
B)call option prices decrease.
C)call option prices remain the same.
D)call option prices can either increase, decrease, or remain the same.

Question 40

Suppose an investor buys one share of stock and a put option on the stock. What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs.)

A)The value of two shares of stock.
B)The value of one share of stock plus the exercise price.
C)The exercise price.
D)The value of one share of stock minus the exercise price.

Question 41

Buying a stock and a put option, and lending the present value of the exercise price provide the same payoff as buying a call option.

Question 42

An American call option gives its owner the right to buy stock at a fixed strike price during a specified period of time.

Question 43

The value of a call option is negatively related to the:
I.exercise price;
II.risk-free rate;
III.time to expiration

A)I only
B)II only
C)III only
D)II and III only

Question 44

The difference between the value of a call option and the stock price less the exercise price is greatest when the option is:

A)out of the money.
B)in the money.
C)at the money.
D)cannot be determined.

Question 45

An increase in exercise price results in an equal increase in the call option's price.

Question 46

For a European option: Value of call + PV(exercise price)= Value of put + Share price.

Question 47

An investor can get downside protection on the purchase of stock by buying a put option.

Question 48

An increase in the underlying stock price results in an increase in a call option's price.

Question 49

The value of any option (both call and put options)is positively related to the
I.volatility of the underlying stock price;
II.time to expiration;
III.risk-free rate;

A)I and II only
B)II and III only
C)I and III only
D)III only

Question 50

The value of a put option is positively related to the:
I.exercise price;
II.time to expiration;
III.volatility of the underlying stock price;
IV.risk-free rate

A)I, II, and III only
B)II, III, and IV only
C)I, II, and IV only
D)IV only

Question 51

If the stock price follows a random walk, successive price changes are statistically independent. If σ² is the variance of the daily price change, and there are t days until expiration, the variance of the cumulative price change is

A)σ²
B)(σ²)× (t).
C)(σ²)/t.
D)(σ²)× (t²).

Question 52

The value of a put option is negatively related to the:
I.stock price;
II.volatility of the underlying stock price;
III.exercise price

A)I only
B)II only
C)I and II only
D)III only

Question 53

The writer of a put option loses if the stock price declines.

Question 54

A profit diagram implicitly neglects the time value of money.

Question 55

The value of a call option is positively related to the following:
I.underlying stock price;
II.risk-free rate;
III.time to expiration;
IV.volatility of the underlying stock price

A)I only
B)II only
C)III only
D)I, II, III, and IV

Question 56

The value of a call option increases as the volatility of the underlying stock price increases.

Question 57

If you write a put option, you acquire the right to buy stock at a fixed strike price.

Question 58

Call options can have a positive value at expiration even when the underlying stock is worthless.

Question 59

A European option gives its owner the right to exercise the option at any time before expiration.

Question 60

Position diagrams and profit diagrams are one and the same.

Question 61

It is possible to replicate an investment in a call option by a levered investment in the underlying asset.

Question 62

Discuss the factors that determine the value of a call option.

Question 63

Buying an in-the-money option will almost always produce a profit.

Question 64

Briefly explain what is meant by put-call parity?

Question 65

Explain the main differences between position diagrams and profit diagrams.

Question 66

All else equal, options written on volatile assets are worth more than options written on safer assets.

Question 67

Briefly discuss the usefulness of position diagrams.

Question 68

Explain the difference between a European option and an American option.

Question 69

Define the term option.

Question 70

Define the term call option.

Question 71

Define the term put option.

Question 72

Briefly explain what is meant by protective put.

Question 73

All else equal, the closer an option gets to expiration, the lower the option price.

Question 74

Briefly explain how an option holder gains from an increase in the volatility of the underlying stock price.

Question 75

Why would an option holder almost never exercise an option early?

Question 76

Briefly explain the relationship between risk and option values.