Deck 14: Options: Puts and Calls

Question 1

Options allow investors to speculate on price movements without a large initial investment.

Answer 1

True

Question 2

Because puts and calls derive their value from the behavior of some other real or financial asset, they are known as derivative securities.

Answer 2

True

Question 3

The owner of a put is obliged to sell the underlying security at the strike price on the date of expiration.

Answer 3

False

Question 4

One reason that writing options can be a viable and profitable investment strategy is that

A) the option writer collects the quarterly dividends.
B) many options expire unexercised.
C) an option writer determines when the option is exercised.
D) an option writer can exercise the option to avoid a potential loss.

Question 5

The writer of an option creates the option by promising to buy or sell the underlying stock if the option holder chooses to exercise their right to sell or buy the underlying stock.

Question 6

Rights and warrants are the riskiest types of options.

Question 7

The buyer of a call option has the right to any dividends paid after the option was purchased, but only if the option is exercised.

Question 8

Which one of the following statements concerning options is correct?

A) One option covers 1,000 shares of stock.
B) A put gives the option holder the right to buy a stated amount of securities.
C) The owner of a call is entitled to the dividends paid on the underlying shares of stock.
D) Option holders can profit on movements of the price of the underlying security.

Question 9

Which of the following is true about rights?

A) They are usually attached to bonds as a "sweetener."
B) The owner has several years in which to exercise the option.
C) They are a type of short-lived call option.
D) They are a type of short-lived put option.

Question 10

The writer of a put or call is the

A) the institution that brings buyers and sellers of an option together in a transaction.
B) can limit risk by letting the option expire unexercised.
C) party who agrees to buy or sell the underlying stock if the option holder chooses to exercise the option.
D) party who guarantees that the terms of the option will be satisfied.

Question 11

Writers of option contracts

A) have a limited liability specified in the contract.
B) hope to exercise the option on favorable terms.
C) earn a commission no matter what subsequently happens to the contract.
D) earn a profit when the option expires without being exercised.

Question 12

Rights are call options issued to current owners of the stock and normally expire within a short period of time.

Question 13

Purchasers of stock options

A) own a financial asset with benefits of firm ownership.
B) have a claim on the profits of the firm issuing the underlying securities.
C) have the obligation to buy or sell a predetermined amount of shares at the strike price.
D) have the right to buy or sell a certain number of underlying shares.

Question 14

An American call option gives the owner

A) the right to buy or sell the stock at the strike price on or before the expiration date.
B) the right but not the obligation to buy the stock at the strike price on or before the expiration date.
C) the right and the obligation to buy the stock at the strike price on or before the expiration date.
D) the right but not the obligation to sell the stock at the strike price on or before the expiration date.

Question 15

Investors who purchase options acquire nothing more than the right to buy or sell the shares of the underlying security.

Question 16

It is riskier to buy an option than to write an option.

Question 17

Warrants are options, often attached to bond issues ,to make the bonds more attractive to investors.

Question 18

Puts and calls are issued by the same corporation that issued the underlying stock.

Question 19

Which of the following statements concerning put options are correct?

A) The writer of a put profits if the price of the underlying stock rises.
B) The writer of a put profits if the price of the underlying stock falls.
C) The owner of a put profits if the price of the underlying stock rises.
D) Both the owner and writer of a put profit when the price of the underlying stock falls.

Question 20

Warrants are short-term options usually expiring within a year or less.

Question 21

European options can only be exercised on the expiration date but can be sold to another investor on any trading day.

Question 22

The majority of today's options are stock options traded primarily on the CBOE and on AMEX.

Question 23

The two provisions which investors should carefully consider when evaluating stock options are the

A) strike price and the exchange ratio.
B) time until expiration and the strike price.
C) leverage ratio and the time to maturity.
D) premium and the discount.

Question 24

The buyer of a listed American option has which of the following rights?
I) the right to change the expiration date
II) the right to change the strike price
III) the right to resell the option
IV) the right to let the option expire unexercised

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

Question 25

Warrants are generally created when

A) a firm decides to execute a stock split.
B) the issuing corporation decides to sweeten a bond issue.
C) a LEAP expires and automatically converts.
D) a financial institution decides to create them based on market conditions.

Question 26

American style options can only be exercised on their expiration dates.

Question 27

An option's strike price is the stock price at which the option holder breaks even.

Question 28

The ability to obtain a given equity position at a reduced capital investment, and therefore magnify returns, is known as

A) leverage.
B) straddling.
C) hedging.
D) triple witching.

Question 29

LEAPS is an acronym for

A) Lehman and Ellsworth Authority Strips.
B) Liability & Equity Asset Securities.
C) LYONS Earnings Anticipation Stocks.
D) Long-Term Equity Anticipation Securities.

Question 30

Listed options are difficult to sell in the secondary market.

Question 31

The writer of a put option hopes that the price of the underlying stock will rise because

A) the option is more likely to be exercised.
B) the option is less likely to be exercised.
C) the buyer of the put will have to purchase the stock at a higher price.
D) the value of the put option will increase in the secondary market.

Question 32

Quotations in an option chain will show
I) the most recent bid and ask prices of the option.
II) puts and calls for the same expiration date.
III) the strike price.
IV) the highest and lowest price for the option in the previous month.

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

Question 33

Standardized options expire on the last business day of the expiration month.

Question 34

Warrants

A) provide substantially less capital appreciation potential than the underlying stock.
B) tend to be quite costly.
C) have a stipulated price and an expiration date.
D) are not traded in the secondary markets because of their low unit costs.

Question 35

LEAPS are a special type of option

A) that must be exercised within six months.
B) that can only be exercised on the expiration date.
C) that cannot be exercised for at least a year after it is is purchased.
D) that may have an expiration date as long as three years.

Question 36

The option premium is

A) the market price of the option.
B) the amount by which the stock price is expected to move before the option expires.
C) the fee charged by the options exchanges for executing transactions.
D) the difference between the strike price and the underlying price of the security.

Question 37

Which one of the following was the first listed exchange for stock options in the United States?

A) Stock Index Board
B) Philadelphia Board of Trade
C) New York Stock Exchange
D) Chicago Board Options Exchange

Question 38

The strike price of a put option is the price

A) an investor must pay for the options contract.
B) of the underlying stock at the time that the options contract is purchased.
C) at which the underlying stock can be sold.
D) at which the underlying stock can be bought.

Question 39

The party that accepts the legal obligation to stand behind the option is the buyer of the contract.

Question 40

If the front month is January, then stock options that trade in the January cycle will have contracts available that expire in

A) January, February, April, and July.
B) March, June, September, December.
C) January, February, March, and April.
D) each of the next 12 months.

Question 41

The buyer of a put expects the price of the underlying stock to rise.

Question 42

Jason purchased a six-month put on ABC stock at a cost of $100. The strike price was $15. At what market price does Jason just break-even on this investment? Ignore transaction costs and taxes.

A) $15
B) $16
C) $14
D) cannot be determined from the information provided

Question 43

NZMA stock is currently selling for $128. Which of the following options is "in-the- money"?

A) March 130 call
B) February 125 call
C) March 125 put
D) February 100 put

Question 44

For a call purchased on an organized security exchange, the strike price specifies the

A) contractual price at which each of the shares of the underlying stock can be bought.
B) prevailing market price of one share of the underlying stock.
C) cost of buying one option contact based on the value of the underlying stock.
D) intrinsic value of the offsetting put.

Question 45

Grant purchased one call on XYZ stock at an exercise price of $25. The market price of XYZ stock when Grant purchased the call was $24 a share. XYZ is currently priced at $30 a share. Grant paid $120 to buy the call. How much profit will Grant make if he exercises the option today and then sells the shares? Ignore all transaction-related costs.

A) $380
B) $480
C) $500
D) $600

Question 46

Investors buy options at the bid price and sell at the ask price.

Question 47

Rex bought a put on Alpha stock with a strike price of $35 when the market price of Alpha stock was $33 a share. Alpha is currently selling at $34 a share. Which of the following statements are true given this information?
I) Rex's option is worth at least $100 today.
II) Rex's option is worthless today.
III) Rex's option has more value today than when he bought it.
IV) Rex's option has less value today than when he bought it.

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

Question 48

The value of a call increases as the price of the underlying security rises.

Question 49

Options premiums tend to be smaller as the time to expiration increases.

Question 50

The value of a put increases as the price of the underlying security rises.

Question 51

The buyer of a put and the writer of a call both profit if the price of the stock falls.

Question 52

The most important factor affecting the market price of a put or call is the

A) market interest rate.
B) expiration date.
C) price behavior of the underlying common stock.
D) price behavior of the corresponding warrant.

Question 53

A put option has a strike price of $32. The current price of the stock is $34. The put option is said to be "in-the-money."

Question 54

The option premium is the price of the option.

Question 55

For all practical purposes, listed stock options always expire

A) on the last business day of the expiration month.
B) on the first Monday of every calendar quarter.
C) on the third Friday of the expiration month.
D) three months from the date of the option purchase.

Question 56

In late November, Karen bought FIB February puts with a strike price of $25. The ask price of the put was $281. The current price of FIB shares is $28.40. The intrinsic value of the put is

A) $340.
B) $(340).
C) $(621).
D) $0.00.

Question 57

Which of the following affect the value of puts and calls written on shares of common stock?
I) price volatility of the underlying stock
II) current market price of the underlying stock
III) length of time until the option expiration date
IV) current market interest rate

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

Question 58

Andrea wrote a three-month call on Echo stock. The option cost $200 and the strike price was $10. What does the market price of Echo have to be for Andrea to break-even on this investment if the option is exercised? Ignore transaction construed taxes.

A) $10
B) $12
C) $8
D) cannot be determined from the information provided

Question 59

The price behavior of the underlying security is the primary determinant of the price of an option.

Question 60

Lew paid $300 to purchase a call on Delta stock with a strike price of $25. What does the market price of Delta have to be for Lew to break-even on his option investment? Ignore transaction costs and taxes.

A) $22
B) $25
C) $28
D) cannot be determined from the information provided

Question 61

The writer of a call option is theoretically exposed to an unlimited loss.

Question 62

What is the time value of a put with a strike price of $30 when the option price is $500 and the underlying common stock sells for $27?

A) $100
B) $200
C) $300
D) $400

Question 63

Jamie wrote a nine-month put on Beta stock. The strike price was $25 and the market price of Beta stock at the time the option was written was $24. The total price of the option contract was $150. At what market price will Jamie just break-even on this investment? Ignore transaction costs and taxes.

A) $23.50
B) $24.00
C) $25.00
D) $26.50

Question 64

The maximum amount the buyer of a put can lose is the cost of the option.

Question 65

Which of the following represent in-the-money options?
I) a call when the market price of the underlying stock exceeds the strike price
II) a call when the strike price exceeds the market price of the underlying stock
III) a put when the market price of the underlying stock exceeds the strike price
IV) a put when the strike price exceeds the market price of the underlying stock

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

Question 66

What is the fundamental value of a put contract with a strike price of $25 when the option price is $150 and the underlying common stock sells for $26?

A) $150
B) $100
C) $0.00
D) -$100

Question 67

Which one of the following options is more expensive? Show all calculations.
(a) A six-month put that carries a $40 strike price on a stock that is currently trading at $35.84, given that the put trades at a 15 percent time value (i.e. the option is trading at a price 15% higher than its intrinsic value); or
(b) A six-month call that carries a $50 strike price on a stock that currently trades at $54.75, while the call trades with a 12 percent time value (i.e. the option is trading at a price 12% higher than its intrinsic value).

Question 68

Nowel Inc. stock is currently priced at $42. The present value of the strike price of a call option on this stock is $44. N(d1), as calculated by the Black Scholes option pricing model is .6541; N(d2) is .3722. The value of this option as calculated by Black-Scholes is

A) $(2.00).
B) $11.10.
C) $2.000.
D) $10.71.

Question 69

If a stock price does not rise or fall by the amount of the option premium, the option will not be exercised.

Question 70

One of the primary advantages of options is the leverage they provide.

Question 71

What is the intrinsic value of a call with a strike price of $40 if the market price of the underlying stock is $44? The call's ask price $540.

A) -$400
B) -$140
C) $940
D) $400

Question 72

Which of the following variables are part of the Black-Scholes option pricing model?
I) the market price of the underlying stock
II) the volatility of the underlying security
III) the strike price of the option
IV) the risk-free rate of interest
V) the beta of the underlying security
VI) the time remaining before the option expires

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

Question 73

A naked option is a conservative investment with limited risk.

Question 74

Paul writes a put with a strike price of $35. The most he could lose by writing the put is
$3,500.

Question 75

The maximum loss that can be incurred as the buyer of an option is the amount of the option premium.

Question 76

The longer the time to expiration, the lower the option time premium tends to be.

Question 77

The prices of puts and calls on the same stock move independently of one another.

Question 78

Options can provide a lot of price action for a limited dollar investment.

Question 79

A put has fundamental value as long as

A) the market price of the underlying financial asset has a positive value.
B) the market price of the underlying financial asset is less than the strike price.
C) the strike price of the put is greater than the time premium of the put.
D) the strike price of the put is less than the market value of the underlying asset.

Question 80

Once the call premium is recouped, the profit from a call is only limited by the price increases of the underlying stock prior to the contract expiration.