Question 1

According to the Black/Scholes option valuation model,the value of a call option increases if

Accepted Answer

The Black/Scholes model assumes that the value of a call option increases as the volatility or fluctuations in the stock price increases. This is captured by the standard deviation of the stock's return, which is one of the inputs in the option valuation formula. Therefore, if the standard deviation of the stock's return increases, the value of the call option will also increase. The other choices (A, B, and C) are not consistent with the Black/Scholes model assumptions.

Question 2

The "collar strategy" is used to lock in profits from an increase in the price of a stock.

Accepted Answer

The collar strategy involves buying a stock and simultaneously buying a put option and selling a call option. This helps to limit potential losses while still allowing for potential profits if the stock price increases.

Question 3

If the hedge ratio is 0.7,the number of call options necessary to offset a long position in a stock is 7.0.

Accepted Answer

The hedge ratio (also known as the delta) indicates the number of options needed to hedge a position in the underlying asset. If the hedge ratio is 0.7, it means you need 1/0.7 options to hedge each share of the stock, not 7 options for the entire position. The calculation for the number of options would depend on the total number of shares you're trying to hedge.

Question 4

The hedge ratio is one piece of information given by the Black/Scholes option valuation model.

Accepted Answer

The Black/Scholes option valuation model provides the hedge ratio, which is the number of shares of the underlying asset that need to be held to hedge one option contract.

Question 5

Put-call parity suggests that the sum of the prices of a stock,a call and a put on that stock,and a debt instrument maturing at the expiration of the options must equal zero.

Accepted Answer

Put-call parity establishes a relationship showing that the price of a call option plus the present value of the strike price (as represented by a risk-free bond maturing on the option's expiration date) equals the price of a put option plus the current stock price. It does not suggest that their sum equals zero.

Question 6

An investor cannot buy and sell two different call options with the same expiration dates.

Accepted Answer

An investor can buy and sell different call options with the same expiration dates, as long as they have different strike prices. This is known as a call spread strategy.

Question 7

The hedge indicates the number of call options that is necessary to offset price movements in the underlying stock.

Accepted Answer

This statement is true. Hedging with call options involves buying a certain number of call options in order to offset price movements in the underlying stock. The number of call options needed will depend on various factors, including the current stock price, the strike price of the options, and the expiration date of the options.

Question 8

According to the Black/Scholes option valuation model,the value of a call option rises as interest rates increase.

Accepted Answer

According to the Black/Scholes option valuation model, an increase in interest rates causes an increase in the value of a call option, all other factors being constant. This is because higher interest rates increase the present value of the option's potential payoff at expiration.

Question 9

According to the Black/Scholes option valuation model,a call option's value increases if

Accepted Answer

The answer of According to the Black/Scholes option valuation model,a...

Question 10

If investors believe that a stock's prices will fluctuate but they are not certain as to the direction,these investors may buy a straddle.

Accepted Answer

A straddle is an options strategy where an investor buys both a call option and a put option for the same stock at the same strike price and expiration date. This allows the investor to profit from price fluctuations in either direction, as they can choose to exercise the call option if the stock price goes up, or the put option if the stock price goes down. Therefore, if investors believe that a stock's prices will fluctuate but they are not certain as to the direction, they may buy a straddle.

Question 11

Since spreads involve buying or selling more than one option,commissions costs tend to increase.

Accepted Answer

Since spreads involve multiple options, the number of transactions increases and thus, the commission costs also tend to increase.

Question 12

The Black/Scholes option valuation model divides the option's strike price by the probability that the option will be exercised.

Accepted Answer

The Black/Scholes option valuation model involves calculating the theoretical value of an option using factors such as the current stock price, strike price, time to expiration, risk-free interest rate, and volatility. It does not divide the option's strike price by the probability of exercise.

Question 13

Put-call parity explains why a change in interest rates by the Federal Reserve must affect stock and option prices.

Accepted Answer

Put-call parity is based on the principle that the price of a call option plus the present value of the exercise price is equal to the price of a put option plus the stock price. If interest rates change, the present value of the exercise price will change, altering the parity equation and causing changes in option and stock prices to maintain parity. Therefore, a change in interest rates by the Federal Reserve will affect stock and option prices.

Question 14

Writing both a put and a call at the same strike price and expiration date is an illustration of a straddle.

Accepted Answer

A straddle involves buying both a put and call option at the same strike price and expiration date, while a strangle involves buying a put and call option at different strike prices. Therefore, writing both a put and call at the same strike price and expiration date would be a short straddle strategy.

Question 15

An investor buys a straddle in anticipation of stable stock prices.

Accepted Answer

A straddle is an options trading strategy in which an investor buys both a put option and a call option with the same strike price and expiration date. This strategy is typically used when the investor anticipates that the stock price will make a significant move in either direction. Therefore, it is not used to anticipate stable stock prices, making option B the correct answer.

Question 16

According to the Black/Scholes option valuation model,a call option's value decreases if

Accepted Answer

According to the Black/Scholes model, a call option's value is positively related to both the variability of the stock's return and the interest rate. Therefore, if the variability of the stock's return declines and/or the interest rate decreases, the call option's value will decrease as well.

Question 17

According to the Black/Scholes option valuation model,the value of a call option rises as it approaches expiration.

Accepted Answer

According to the Black/Scholes option valuation model, the value of a call option typically decreases as it approaches expiration due to the reduction in time value, assuming all other factors remain constant.

Question 18

According to put-call parity,if a stock is overvalued,the investor should sell the stock short,sell the put,buy the call,and buy the bond.

Accepted Answer

Put-call parity states that the value of a stock plus the value of a put option minus the value of a call option equals the value of a bond with the same maturity. If a stock is overvalued, then the value of the stock is greater than the value of the bond. This means that the value of the put option must be less than the value of the call option. Therefore, an investor can profit by selling the stock short, selling the put, buying the call, and buying the bond.

Question 19

If an individual sells a stock short,that investor is protected from a large increase in the price of the stock by selling a call option.

Accepted Answer

If an individual sells a stock short, they are betting that the price of the stock will decrease. Selling a call option would give someone else the right to buy the stock at a certain price, which actually puts the seller of the short position at more risk if the price of the stock increases. Therefore, selling a call option would not protect the investor from a large increase in the price of the stock.

Question 20

The protective call strategy is an illustration of a short position.

Accepted Answer

The protective call strategy is actually an illustration of a long position, as it involves buying a call option to protect against potential losses in a long stock position.

Quiz 20: Option Valuation and Strategies