Question 1

Suppose you purchase a call option for $5 and a strike price of $40. On the expiration day, the price of the stock is $55. What is the return on the call option if you hold your position until maturity?

Accepted Answer

B) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = $0, if Stock Price is less than or equal to Strike Price
Return = (Option payoff - cost) / cost
Option payoff = $55 - $40 = $15
Return = ($15 - $5) / $5 = 200%

Question 2

Suppose that a stock sells at a price of $60 on the expiration date. Compute the price of a call option if the option strike price is $20.

Accepted Answer

C) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = $0, if Stock Price is less than or equal to Strike Price.
So, call option = $60 - $20 = $40

Question 3

Suppose that a stock sells at a price of $40 on the expiration date. Compute the payoff to the seller of a call option if the option strike price is $20.

Accepted Answer

A) The payoff to the seller is negative of the payoff to holder of call option. So, payoff or loss to seller of a call option is -(stock price - strike price) = -($40 - $20) = -$20.

Question 4

Suppose that a stock sells at a price of $50 on the expiration date. Compute the price of a put option if the option strike price is $80.

Accepted Answer

B) Price of a put option = Strike Price - Stock Price, if Strike Price is greater than Stock Price;
Price of a put option = $0, if Strike Price is less than or equal to Stock Price.
So, put option = $80 - $50 = $30

Question 5

Suppose that a stock sells at a price of $40 on the expiration date. Compute the price of a put option if the option strike price is $60.

Accepted Answer

A) Price of a put option = Strike Price - Stock Price, if Strike Price is greater than Stock Price;
Price of a put option = $0, if Strike Price is less than or equal to Stock Price.
So, put option = $60 - $40 = $20

Question 6

Use the figure for the question below. 
-This graph depicts the payoffs of a ________.

Accepted Answer

The graph represents a short position in a call option at expiration, where the payoff increases as the underlying asset's price decreases, up to a point (the option's strike price), and then decreases as the asset's price increases beyond the strike price. This is characteristic of the risk and payoff profile for someone who has sold a call option.

Question 7

Suppose that a stock sells at a price of $40 on the expiration date. Compute the price of a put option if the option strike price is $20.

Accepted Answer

A) Price of a put option = Strike Price - Stock Price, if Strike Price is greater than Stock Price;
Price of a put option = $0, if Strike Price is less than or equal to Stock Price.
So, put option = $0

Question 8

Suppose that a stock sells at a price of $40 on the expiration date. Compute the payoff to the seller of a call option if the option strike price is $50.

Accepted Answer

C) As stock price of $40 is less than strike price of $50, so the call option will not be exercised, and seller will have no obligation.

Question 9

The payoff to the holder of a call option is ________.

Accepted Answer

The payoff to the holder of a call option is the difference between the stock price and the strike price if the stock price is more than the strike price. If the stock price is less than the strike price, the payoff will be zero. Therefore, option D is the correct choice.

Question 10

Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $20.

Accepted Answer

C) If the strike price is less than stock price, put option will not be exercised and the payoff to the seller of a put option will be zero.

Question 11

When a stock price appreciates by a certain percentage, a call option on the same stock appreciates by a lower percentage amount.

Accepted Answer

This statement is false. When a stock price appreciates, the value of a call option on the same stock also appreciates, but the percentage increase may not necessarily be lower. The percentage increase in the value of a call option is determined by other factors such as the strike price, time to expiration, and implied volatility.

Question 12

The payoff to the holder of a put option is ________.

Accepted Answer

The payoff to the holder of a put option is the strike price minus the stock price, but only when the stock price is less than the strike price. This is because a put option gives the holder the right to sell the underlying asset at the strike price, which is beneficial if the market price is below the strike price.

Question 13

Suppose that a stock sells at a price of $10 on the expiration date. Compute the price of a call option if the option strike price is $20.

Accepted Answer

D) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = 0, if Stock Price is less than or equal to Strike Price. As Stock Price is less than Strike Price so, call option = $0

Question 14

An investor purchases a call option and its underlying stock on the same day. If the stock appreciates by 25%, the call option will appreciate by ________.

Accepted Answer

When an investor purchases a call option and the underlying stock on the same day, it is known as a covered call strategy. In this case, if the stock appreciates by 25%, the call option priced will also appreciate by more than 25%. This is because the investor has already purchased the stock, and the call option will now be "in the money," which will result in a higher profit potential.

Question 15

Suppose that a stock sells at a price of $40 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $50.

Accepted Answer

B) The payoff to the seller is negative of the payoff to holder of call option. So, payoff or loss to seller of a call option is -(strike price - stock price) = -($50 - $40) = -$10.

Question 16

Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $80.

Accepted Answer

A) The payoff to the seller is negative of the payoff to holder of call option. So, payoff or loss to seller of a call option is -(strike price - stock price) = -($80 - $60) = -$20.

Question 17

Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a call option if the option strike price is $20.

Accepted Answer

C) The payoff to the seller is negative of the payoff to holder of the call option. So, payoff or loss to seller of a call option is -(stock price - strike price) = -($60 - $20) = -$40.

Question 18

Suppose you purchase a call option for $4 and a strike price of $30. On the expiration day, the price of the stock is $40. What is the return on the call option if you hold your position until maturity?

Accepted Answer

C) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = $0, if Stock Price is less than or equal to Strike Price.
Return = (Option payoff - cost) / cost
Option payoff = $40 - $30
Return = ($10 - $4) / $4 = 150%

Question 19

Suppose that a stock sells at a price of $40 on the expiration date. Compute the price of a call option if the option strike price is $20.

Accepted Answer

A) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = $0, if Stock Price is less than or equal to Strike Price.
So, call option = $40 - $20 = $20

Question 20

Suppose you purchase a call option for $5 and a strike price of $20. On the expiration day, the price of the stock is $30. What is the return on the call option if you hold your position until maturity?

Accepted Answer

D) Price of a call option = Stock Price - Strike Price, if Stock Price is greater than Strike Price;
Price of a call option = $0, if Stock Price is less than or equal to Strike Price.
Return = (Option payoff - cost) / cost
Option payoff = $30 - $20
Return = ($10 - $5) / $5 = 100%

Quiz 21: Option Applications and Corporate Finance