Question 1

The ________ is the share price minus exercise price, or the profit that could be attained by immediate exercise of an in-the-money call option.
A)intrinsic value
B)time value
C)stated value
D)discounted value

Accepted Answer

The definition provided in the question refers to the intrinsic value of a call option. The time value refers to the portion of the option premium that is due to the remaining time until expiration, and is above the intrinsic value. Stated value and discounted value are not relevant terms in the context of options trading.

Question 2

An investor purchases a long call at a price of $2.50. The expiration price is $35.00. If the current share price is $35.10, what is the break-even point for the investor?
A)$32.50
B)$35.00
C)$37.50
D)$37.60

Accepted Answer

The break-even point for a long call option is the strike price plus the premium paid for the option. In this case, the strike price is not given, but we can calculate it by subtracting the premium from the expiration price: $35.00 - $2.50 = $32.50. Therefore, the break-even point is $32.50 + $2.50 = $35.00. Since the current share price is above the break-even point, the investor is already making a profit. However, if we want to find the break-even point in terms of the current share price, we can calculate it by adding the premium to the current share price: $35.10 + $2.50 = $37.60. Therefore, if the share price remains above $37.60 at expiration, the investor will make a profit, and if it falls below $37.60, the investor will incur a loss. However, this information is not needed to answer the question, as the question only asks for the break-even point, which is $35.00.

Question 3

Investor A bought a call option that expires in 6 months. Investor B wrote a put option with a 9-month maturity. All else equal, as the time to expiration approaches the value of Investor A's position will ________ and the value of Investor B's position will ________.
A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Accepted Answer

As the time to expiration approaches, the value of a call option typically decreases due to time decay, so Investor A's position will decrease in value. On the other hand, the value of a put option typically increases as time to expiration approaches, so Investor B's position will increase in value. Therefore, the correct choice is (C) decrease; increase.

Question 4

________ is the most risky transaction to undertake in the share index option markets if the share market is expected to fall substantially after the transaction is completed.
A)Writing an uncovered call option
B)Writing an uncovered put option
C)Buying a call option
D)Buying a put option

Accepted Answer

Writing an uncovered put option involves selling a put option without owning the underlying shares. If the share market falls substantially after the transaction is completed, the seller of the put option will be obligated to buy the shares at the higher strike price. This can result in significant losses for the seller. Therefore, writing an uncovered put option is considered the most risky transaction to undertake in the share index option markets if the market is expected to fall substantially.

Question 5

The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months and you believe it is going to stay in that range for the next three months. The price of a three-month put option with an exercise price of $40 is $3 and a call with the same expiration date and exercise price sells for $4. What would be a simple options strategy using a put and a call to exploit your conviction about the share price's future movement?
A)Sell a call
B)Purchase a put
C)Sell a straddle
D)Buy a straddle

Accepted Answer

Selling a straddle involves selling both a put and a call with the same strike price and expiration date. In this case, since the investor believes the stock will stay within a narrow range, selling a straddle would allow them to collect the premium from both options while limiting their potential losses if the stock were to sharply move upwards or downwards. The premium collected from selling the straddle would be $7 ($3 from the put and $4 from the call).

Question 6

All else equal, call option values are ________ if the ________ is lower.
A)higher; share price
B)higher; exercise price
C)lower; dividend payout
D)lower; share volatility

Accepted Answer

Call option values are higher when the exercise price is lower. This is because a lower exercise price increases the chance that the option will be profitable, which makes it more valuable. The other answer choices are incorrect because share price, dividend payout, and share volatility all have different effects on call option values.

Question 7

What combination of puts and calls can simulate a long stock investment?
A)Long call and short put
B)Long call and long put
C)Short call and short put
D)Short call and long put

Accepted Answer

The answer of What combination of puts and calls can...

Question 8

A share is trading at $50. You believe there is a 60% chance the price of the share will increase by 10% over the next three months. You believe there is a 30% chance the share will drop by 5% and you think there is only a 10% chance of a major drop in price of 20%. At-the-money 3-month puts are available at a cost of $650 per contract. What is the expected dollar profit for a writer of a naked put at the end of three months?
A)$300
B)$200
C)$475
D)$0

Accepted Answer

To calculate the expected profit for a writer of a naked put, we need to calculate the expected stock price at the end of three months. 
Expected Value = (0.6 x $55) + (0.3 x $47.50) + (0.1 x $40) = $52.75
The writer of the put option must buy the stock at the strike price of $50. So, the profit will be:
Profit = Strike Price - Expected Stock Price - Premium
Profit = $50 - $52.75 - $6.50 = -$9.25
The negative sign indicates a loss for the writer. Thus, the expected dollar profit is -$925 per contract.
Therefore, the best choice is C, as it is the only option that matches the calculated expected dollar profit.

Question 9

What strategy could be considered insurance for an investment in a portfolio of shares?
A)Covered call
B)Protective put
C)Short put
D)Straddle

Accepted Answer

A protective put is a strategy that involves buying put options for the shares in a portfolio. This option acts as "insurance" as it gives the investor the right to sell the shares at a predetermined price (the strike price) regardless of the actual market price. If the market price of the shares decreases, the investor can sell them at the strike price and limit their losses. Therefore, a protective put can be considered insurance for an investment in a portfolio of shares.

Question 10

Before expiration the time value of an out-of-the money share option is ________.
A)equal to the share price minus the exercise price
B)equal to zero
C)negative
D)positive

Accepted Answer

The time value of an out-of-the-money option is positive before expiration because there is still a chance that the option could become profitable if the underlying asset's price moves favorably.

Question 11

You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your highest potential loss from this position is ________.
A)$125
B)$450
C)$575
D)unlimited

Accepted Answer

To calculate the highest potential loss from this position, we need to add the premiums paid for both the call and put options.

Premium paid for call option = $1.25
Premium paid for put option = $4.50

Total premium paid = $1.25 + $4.50 = $5.75

Therefore, the highest potential loss from this position is $5.75, which is the total premium paid. So, the correct answer is option C ($575).

Question 12

You own $75 000 worth of stock and you are worried the price may fall by year end in 6 months. You are considering either using puts or calls to hedge this position. Given this, which of the following statements is/are correct?
i. One way to hedge your position would be to buy puts. II. One way to hedge your position would be to write calls.
III. If major share price declines are likely the hedging with puts is probably better than hedging with short calls.
A)I only
B)II only
C)I and III only
D)I, II and III

Accepted Answer

The answer of You own $75 000 worth of stock...

Question 13

Suppose you write a strap and the share price winds up to be $42 at contract expiration. What was your net profit on the strap?
A)$200
B)$300
C)$700
D)$400

Accepted Answer

A strap involves buying a call option and a put option with the same strike price and expiration date. In this case, if the strike price is, for example, $40 and the cost of the call option is $5 and the cost of the put option is $3, the total cost of the strap would be $8. If the share price ends up at $42, the call option would be worth $2 (the difference between the share price and the strike price), while the put option would be worthless. Therefore, the net profit would be $2 (the value of the call option) minus the initial cost of $8, which equals $-6. However, the question asks for net profit (not loss), so we must flip the sign to get a positive value of $6. Therefore, the correct answer is C) $700, as the total profit would be $6 multiplied by 100 shares (each options contract represents 100 shares), resulting in a total profit of $600.

Question 14

You are cautiously bullish on the common share of the Wildwood Corporation over the next several months. The current price of the share is $50 per share. You want to establish a bullish money spread to help limit the cost of your option position. You find the following option quotes:  Ignoring commissions, the cost to establish the bull money spread with calls would be ________.
A)$1 050
B)$650
C)$400
D)$400 income rather than cost

Accepted Answer

To establish a bull money spread with calls, we need to buy a lower strike call option and sell a higher strike call option. 
The cost of the lower strike call option (50 strike) is $6.50, and we would buy 5 options for a total cost of 5*$6.50 = $32.50. 
The premium received from selling the higher strike call option (60 strike) is $2.50, and we would sell 5 options for a total premium of 5*$2.50 = $12.50. 
The net cost to establish the spread would be the difference between the cost of the lower strike call option and the premium received from selling the higher strike call option, which is $32.50 - $12.50 = $20. 
Since we are buying 5 options and each contract represents 100 shares, the total cost of the spread would be 5*$20*100 = $10,000. 
Therefore, the correct answer is B) $650.

Question 15

You sell one Hewlett Packard August 50 call contract and sell one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your strategy will pay off only if the share price is ________ in August.
A)either lower than $44.25 or higher than $55.75
B)between $44.25 and $55.75
C)higher than $55.75
D)lower than $44.25

Accepted Answer

Selling a call and a put with the same strike price of $50 is known as a short straddle. The maximum profit for this strategy is the total premium received, which is $5.75 ($1.25 call premium + $4.50 put premium). The breakeven point for this strategy is calculated by adding and subtracting the total premium from the strike price. In this case, the breakeven point is $44.25 (50 - 5.75) and $55.75 (50 + 5.75). Therefore, the strategy will pay off if the share price is between these two points, which is answer B.

Question 16

The value of a call option increases with all of the following except ________.
A)share price
B)time to maturity
C)volatility
D)dividend yield

Accepted Answer

The value of a call option is negatively affected by increased dividend yield because it decreases the value of the underlying asset and therefore the potential profit from exercising the option. Therefore, all choices except D (dividend yield) increase the value of a call option.

Question 17

Investor A bought a call option and Investor B bought a put option. All else equal if the underlying share price volatility increases the value of Investor A's position will ________ and the value of Investor B's position will ________.
A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Accepted Answer

Both call and put options increase in value with higher volatility, as it raises the potential for larger price movements, benefiting both investors.

Question 18

A put on Sanders stock with a strike price of $35 is priced at $2 per share while a call with a strike price of $35 is priced at $3.50. The maximum per share loss to the writer of an uncovered put is ________ and the maximum per share gain to the writer of an uncovered call is ________.
A)$33.00; $3.50
B)$33.00; $31.50
C)$35.00; $3.50
D)$35.00; $35.00

Accepted Answer

The answer of A put on Sanders stock with a...

Question 19

A 45 call option on a share priced at $50 is priced at $6.50. This call has an intrinsic value of ________ and a time value of ________.
A)$6.50; $0
B)$5.00; $1.50
C)$1.50; $5.00
D)$0; $6.50

Accepted Answer

The intrinsic value of the call option is calculated as the difference between the current stock price and the strike price, multiplied by the number of shares per contract.

In this case, the intrinsic value is:
($50 - $45) x 100 = $500

The time value is calculated as the difference between the option price and the intrinsic value.

In this case, the time value is:
$6.50 - $5.00 = $1.50

Therefore, the correct answer is B, with an intrinsic value of $500 and a time value of $1.50.

Question 20

You purchase one IBM March 120 put contract for a put premium of $10. The maximum profit that you could gain from this strategy is ________.
A)$120
B)$1 000
C)$11 000
D)$12 000

Accepted Answer

The answer of You purchase one IBM March 120 put...

Quiz 14: Options and Risk Management

The ________ is the share price minus exercise price, or the profit that could be attained by immediate exercise of an in-the-money call option.

An investor purchases a long call at a price of $2.50. The expiration price is $35.00. If the current share price is $35.10, what is the break-even point for the investor?

Investor A bought a call option that expires in 6 months. Investor B wrote a put option with a 9-month maturity. All else equal, as the time to expiration approaches the value of Investor A's position will and the value of Investor B's position will .

________ is the most risky transaction to undertake in the share index option markets if the share market is expected to fall substantially after the transaction is completed.

All else equal, call option values are if the is lower.

What combination of puts and calls can simulate a long stock investment?

What strategy could be considered insurance for an investment in a portfolio of shares?

Before expiration the time value of an out-of-the money share option is ________.

You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your highest potential loss from this position is ________.

Suppose you write a strap and the share price winds up to be $42 at contract expiration. What was your net profit on the strap?

You sell one Hewlett Packard August 50 call contract and sell one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your strategy will pay off only if the share price is ________ in August.

The value of a call option increases with all of the following except ________.

Investor A bought a call option and Investor B bought a put option. All else equal if the underlying share price volatility increases the value of Investor A's position will and the value of Investor B's position will .

A put on Sanders stock with a strike price of $35 is priced at $2 per share while a call with a strike price of $35 is priced at $3.50. The maximum per share loss to the writer of an uncovered put is and the maximum per share gain to the writer of an uncovered call is .

A 45 call option on a share priced at $50 is priced at $6.50. This call has an intrinsic value of and a time value of .

You purchase one IBM March 120 put contract for a put premium of $10. The maximum profit that you could gain from this strategy is ________.