Deck 14: Options Markets

Question 1

The sale of a call option on a stock the seller already owns is referred to as

A)a covered call.
B)a naked call.
C)call on futures.
D)futures on options.

Answer 1

A

Question 2

A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. What is the stock price at which the speculator would break even?

A)$50
B)$58
C)$52
D)$53
E)$49

Answer 2

D

Question 3

A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. The speculator will exercise the option on the expiration date (if it is feasible to do so). What is the speculator's profit per unit?

A)$1
B)$5
C)$2
D)-$1
E)-$2

Answer 3

$2

Question 4

A put option is "out of the money" when the

A)market price of the security exceeds the exercise price.
B)market price of the security equals the exercise price.
C)market price of the security is less than the exercise price.
D)premium on the option is less than the exercise price.

Question 5

A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29, and rises to $32 before the expiration date. What is the maximum profit per unit to the speculator who owned the put option assuming he or she exercises the option at the ideal time?

A)-$4
B)-$3
C)-$2
D)$2
E)$3

Question 6

The longer the time to maturity, the ____ the call option premium and the ____ the put option premium.

A)higher; lower
B)lower; higher
C)higher; higher
D)lower; lower

Question 7

The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option premium.

A)higher; lower
B)lower; higher
C)higher; higher
D)lower; lower

Question 8

The ____, the lower the premium on a put option, other things being equal.

A)higher the existing price of the security relative to the exercise price
B)greater the variability of the security's market value
C)longer the maturity of the option
D)A and B

Question 9

When the exercise price exceeds the market price of the underlying security, the

A)call option is in the money.
B)put option is in the money.
C)call option is at the money.
D)put option is out of the money.

Question 10

The ____, the higher the call option premium, other things being equal.

A)lower the existing price of the security relative to the exercise price
B)lower the variability of the security's market price
C)longer the maturity of the option
D)A and B

Question 11

A ____ requires a premium above and beyond the price to be paid for the financial instrument.

A)futures contract
B)call option
C)put option
D)B and C

Question 12

____ execute transactions desired by investors and trade stock options for their own account.

A)Floor brokers
B)Discount brokers
C)Market-makers
D)none of the above

Question 13

Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4 premium per share. The pension fund sells a call option on the stock it owns. If the call option is exercised when the price of the stock is $56, what is the gain or loss per share to the pension fund (including its gain from holding the stock as well)?

A)$4 gain
B)$6 loss
C)$2 loss
D)$1 gain
E)$0

Question 14

When the market price of the underlying security exceeds the exercise price, the

A)call option is in the money.
B)put option is in the money.
C)call option is at the money.
D)call option is out of the money.

Question 15

Sellers (writers) of call options can offset their position at any point in time by

A)selling a put option on the same stock.
B)buying identical call options.
C)selling additional call options on the same stock.
D)all of the above
E)A and B

Question 16

A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29, and rises to $32 before the expiration date. What is the stock price at which the speculator would break even?

A)$26
B)$34
C)$28
D)$29
E)$32

Question 17

A call option is "in the money" when the

A)market price of the underlying security exceeds the exercise price.
B)market price of the underlying security equals the exercise price.
C)market price of the underlying security is less than the exercise price.
D)premium on the option is less than the exercise price.

Question 18

The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.

Question 19

A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.

A)call option
B)put option
C)sale of a futures contract
D)purchase of a futures contract

Question 20

The ____ is the most important exchange for trading options.

A)New York Stock Exchange (NYSE)
B)Chicago Board of Options Exchange (CBOE)
C)Boston Options Exchange
D)American Stock Exchange

Question 21

Long-term equity anticipations (LEAPS) represent

A)stocks that have a maturity date.
B)stocks that are converted to bonds once the price reaches a specified level.
C)stock options with longer terms to expiration than the more traditional stock options.
D)stock index futures that can have a more distant settlement date than the more typical stock options.

Question 22

If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____ than the exercise price when the payables are due.

A)exercise the option; greater
B)exercise the option; less
C)let the option expire; greater
D)let the option expire; less
E)A and D

Question 23

The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 24

The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 25

Corporations involved in international business transactions can ____ to hedge future ____.

A)sell currency call options; payables
B)purchase currency put options; receivables
C)purchase currency call options, receivables
D)purchase currency put options, payables
E)A and B

Question 26

European-style stock options

A)are long-term options (at least one year until expiration at the time they are created).
B)can be exercised after the expiration date.
C)can be exercised any time until the expiration date.
D)none of the above

Question 27

The premium on an existing put option should ____ when the underlying stock price increases.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 28

Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a premium of 14, with an exercise price of 1800. The value of an S&P 500 futures contract is 250 times the index. If the index on the futures contract increases to 1830, what is the gain on the sale of the futures contract?

A)$15,000
B)$7,500
C)$3,300
D)$4,000
E)$1,500

Question 29

When a stock index option is exercised, the cash payment is equal to a specified dollar amount

A)multiplied by the index level.
B)multiplied by the exercise price.
C)multiplied by the difference between the index level and the exercise price.
D)multiplied by the sum of the index level and the exercise price.

Question 30

Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar.

A)put; strengthen
B)put; weaken
C)call; strengthen
D)call; weaken
E)A and D

Question 31

Speculators purchase currency ____ on currencies they expect to ____ against the dollar.

A)call options; weaken
B)put options; strengthen
C)futures; weaken
D)put options; weaken

Question 32

A savings institution has long-term fixed rate mortgages supported by short-term funds. A put option on Treasury bond futures could be used to (ignore the premium paid for the option when you answer this question)

A)maintain its interest rate spread if interest rates rise, and increase its spread if interest rates fall.
B)maintain its interest rate spread if interest rates fall, and increase its spread if interest rates rise.
C)maintain its interest rate spread whether interest rates rise or fall.
D)increase its interest rate spread whether interest rates rise or fall.

Question 33

The premium on an existing call option should ____ when the underlying stock price decreases.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 34

A speculator purchased a put option with an exercise price of $56 for a premium of $10. The option was exercised a few days later when the stock price was $44. What was the return to the speculator?

A)-20 percent
B)120 percent
C)-100 percent
D)20 percent

Question 35

Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.

A)increases; increases
B)increases; decreases
C)limits; increases
D)limits; decreases

Question 36

The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 37

The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.

A)be negative
B)decline
C)increase
D)be unaffected
E)A and B

Question 38

A speculator purchases a put option on Treasury bond futures with a September delivery date with a strike price of 85-00. The option has a premium of 2-00. Assume that the price of the futures contract decreases to 82-00 on the expiration date and the option is exercised at that point (if it is feasible). What is the net gain?

A)$1,968.75
B)$3,750.00
C)$3,000.00
D)-$2,000.00
E)$1,000.00

Question 39

A speculator purchased a call option with an exercise price of $31 for a premium of $4. The option was exercised a few days later when the stock price was $34. What was the return to the speculator?

A)25 percent
B)-25 percent
C)-3.2 percent
D)-2.9 percent

Question 40

Put options are typically used to hedge

A)when portfolio managers are mainly concerned with a permanent decline in a stock's value.
B)when portfolio managers are mainly concerned with a permanent increase in a stock's value.
C)when portfolio managers are mainly concerned with a temporary decline in a stock's value.
D)when portfolio managers are mainly concerned with a temporary increase in a stock's value.

Question 41

An option with a higher exercise price has a higher call option premium and a lower put option premium.

Question 42

Market makers can execute stock option transactions for customers and do not trade stock options for their own account.

Question 43

American-style stock options can be exercised only just before expiration.

Question 44

On an exchange, option trades can be executed

A)by a floor broker.
B)electronically.
C)by a market maker.
D)all of the above
E)A and B only

Question 45

Which of the following is not an assumption underlying the Black-Scholes option-pricing model?

A)The risk-free rate is known and constant over the life of the option.
B)The probability distribution of stock prices is lognormal.
C)The world is risk-neutral.
D)The variability of a stock's return is constant.
E)There are no transaction costs involved in trading options.

Question 46

Marcie purchases a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, Marcie decides to exercise the option and closes out the position by selling an identical futures contract. Marcie's net gain from this strategy is $____.

A)-2,687.50
B)2,687.50
C)2,375.00
D)7,437.50
E)none of the above

Question 47

A call option is said to be at the money when the market price of the underlying security exceeds the exercise price.

Question 48

When stock portfolio managers use dynamic asset allocation by writing call options on a stock index, they ____ their exposure to stock market conditions.

A)reduce
B)completely eliminate
C)have no effect on
D)increase

Question 49

Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been established ____.

A)available; in numerous non-U.S. countries
B)not available; in numerous non-U.S. countries
C)available; only in the United States
D)not available; only in the United States

Question 50

When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____ their exposure to stock market conditions.

A)reduce
B)completely eliminate
C)have no effect on
D)increase

Question 51

Which of the following is not true with respect to market makers?

A)They benefit from the spread.
B)They may earn profits when they take positions in options.
C)They are not subject to the risk of loss on their positions in options.
D)All of the above are true with respect to market makers.

Question 52

When investors purchase an option that does not hedge their existing investments, the option can be referred to as "naked."

Question 53

Which of the following is not a difference between purchasing an option and purchasing a futures contract?

A)The option requires that a premium be paid in addition to the price of the financial instrument.
B)Owners of options can choose to let the option expire on the so-called expiration date without exercising it.
C)The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not.
D)All of the above are differences between purchasing an option and purchasing a futures contract.

Question 54

Option trading is regulated by the

A)Options Clearing Corporation.
B)International Securities Exchange.
C)Securities and Exchange Commission.
D)Federal Reserve.

Question 55

The writer of a put option is obligated to provide the specified financial instrument at the price specified by the option contract if the owner exercises the option.

Question 56

Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their risk.

Question 57

Vince, a speculator, expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 93-22. Vince exercises the option and closes out the position by purchasing an identical futures contract. Vince's net gain from this speculative strategy is $____.

A)-406.25
B)4,718.75
C)-4,718.75
D)-812.50
E)none of the above

Question 58

Backdating implies that CEO (or other executives) reset the date that their options were granted to a different date when the stock price was lower.

Question 59

The motive for a CEO to backdate options is that it allowed them to exercise the options at a lower exercise price.

Question 60

Reese Insurance company sold a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, the option was exercised as the buyer closed out the position by selling an identical futures contract. Reese's net gain from selling the call option is $____.

A)2,687.50
B)-2,687.50
C)2,375.00
D)7,437.50
E)none of the above

Question 61

The results with covered call writing are better than without covered call writing when the stock performs poorly and better when the stock performs well.

Question 62

Which of the following statements is incorrect?

A)Some firms allowed their CEOs to backdate options that they were granted to an earlier period when the stock price was lower.
B)Backdating is completely inconsistent with the idea of granting options to encourage managers to focus on maximizing the stock price.
C)Firms readily promote their option compensation programs and are more than willing to acknowledge that the options are an expense.
D)All of the above are correct.

Question 63

Options on small stocks normally have higher premiums than options on large stocks because small stocks typically are more volatile.

Question 64

The ____ is not a factor affecting the call option premium.

A)market price of the underlying instrument (relative to option's exercise price)
B)volatility of the underlying instrument
C)current price of futures contracts on the underlying instrument
D)time to maturity of the call option

Question 65

Speculators sell call options on currencies that they expect to strengthen against the dollar.

Question 66

Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury bond futures.

A)purchasing; put
B)selling; call
C)purchasing; call
D)none of the above

Question 67

Assuming the same expiration date, an option with a ____ exercise price has a ____ call option premium and a ____ put option premium.

A)higher; higher; higher
B)higher; higher; lower
C)higher; lower; higher
D)lower; lower; higher
E)none of the above

Question 68

Put options are more typically used to hedge when portfolio managers are mainly concerned about a temporary decline in a stock's value.

Question 69

The longer a call option's time to maturity, the lower the call option premium, other things being equal.

Question 70

Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 93-22. Brad exercises the option and closes out the position by purchasing an identical futures contract. Brad's net gain from this speculative strategy is $____.

A)-812.50
B)4,718.75
C)-4,718.75
D)-406.25
E)none of the above

Question 71

Which of the following does not directly affect a call option premium?

A)volatility of the underlying instrument
B)market price of the underlying instrument
C)analyst rating of the underlying instrument
D)time to maturity of the option

Question 72

Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury bond futures.

Question 73

The purchaser of an American-style put option is always better off exercising the option at the expiration date than before that date.

Question 74

Market makers

A)can execute stock option transactions for their customers.
B)can trade options for their own account.
C)are subject to the risk of losses from their positions in options.
D)benefit from the spread.
E)all of the above

Question 75

Speculators who anticipate a sharp increase in stock market prices overall may consider purchasing put options on one of the market indexes.

Question 76

____ of options can close out their positions at any time by ____ an identical option.

A)Sellers; purchasing
B)Sellers; selling
C)Buyers; purchasing
D)none of the above

Question 77

Several call options are available for a given stock, and the risk-return potential will vary among them.

Question 78

The greater the existing market price of the underlying financial instrument relative to the exercise price, the higher the put option premium, other things being equal.

Question 79

An increase in uncertainty results in a higher implied standard deviation for the stock, which means that the writer of an option requires a higher premium to compensate for the anticipated increase in the stock's volatility.

Question 80

Which of the following statements is least correct regarding corporations involved in international business transactions?

A)They may purchase currency put options to hedge future receivables denominated in a foreign currency.
B)They may purchase currency call options to hedge future payables denominated in a foreign currency.
C)They may purchase currency call options to hedge future receivables denominated in a foreign currency.
D)They benefit from currency put options if the currency's value declines before the expiration date of the option.