Deck 16: Understanding Options

Question 1

In June 2007, an investor buys a call option on Amgen stock with an exercise of price of $65 and expiring in January 2009. If the stock price in June 2003 is $60, then this option is:
I. in-the-money
II. out-of-the-money
III. a LEAPS

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

Answer 1

II and III only

Question 2

The writer (seller) of a regular exchange-listed call-option on the stock:

A) has the right to buy 100 shares of the underlying stock at the exercise price
B) has the right to sell 100 shares of the underlying stock at the exercise price
C) has the obligation to buy 100 shares of the underlying stock at the exercise price
D) has the obligation to sell 100 shares of the underlying stock at the exercise price

Answer 2

has the obligation to sell 100 shares of the underlying stock at the exercise price

Question 3

Figure-4 depicts the:

A) position diagram for the writer (seller) of a call option
B) profit diagram for the writer (seller) of a call option
C) position diagram for the writer (seller) of a put option
D) profit diagram for the writer (seller) of a put option

Answer 3

position diagram for the writer (seller) of a call option

Question 4

Firms regularly use the following to reduce risk:
I. Currency options
II. Interest-rate options
III. Commodity options

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

Question 5

The Position diagram for a put with the same exercise price and premium as the call on the same underlying asset with the same maturity is (like):

A) the inverse of the call diagram along the put price
B) unrelated to the call diagram no matter what the exercise price
C) the mirror image of the call diagram around the exercise price
D) exactly the same as the call diagram for the given exercise price

Question 6

Figure-1 depicts the:

A) position diagram for the buyer of a call option
B) profit diagram for the buyer of a call option
C) position diagram for the buyer of a put option
D) profit diagram for the buyer of a put option

Question 7

An investor, in practice, can buy:
I. an option on a single share of stock
II. options that are in multiples of 100
III. a minimum order of 100 options on a share of stock

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

Question 8

The writer (seller) of a regular exchange-listed put-option on the stock:

A) has the right to buy 100 shares of the underlying stock at the exercise price
B) has the right to sell 100 shares of the underlying stock at the exercise price
C) has the obligation to buy 100 shares of the underlying stock at the exercise price
D) has the obligation to sell 100 shares of the underlying stock at the exercise price

Question 9

An option that can be exercised any time before expiration date is called:

A) an European option
B) an American option
C) a call option
D) a put option

Question 10

A put option gives the owner the right:

A) and the obligation to buy an asset at a given price
B) and the obligation to sell an asset at a given price
C) but not the obligation to buy an asset at a given price
D) but not the obligation to sell an asset at a given price

Question 11

The two principal options exchanges in the U.S.A. are:
I. International Securities Exchange
II. New York Stock Exchange
III. NASDAQ
IV. Chicago Board of Options Exchange

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

Question 12

The following are examples of disguised options for firms:
I. acquiring growth opportunities
II. ability of the firm to terminate a project when it is no longer profitable
III. options that are associated with corporate securities that provide flexibility to change the terms of the issues

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

Question 13

The buyer of a call option has the right to exercise, but the writer of the call option has:

A) The choice to offset with a put option
B) The obligation to deliver the shares at exercise price
C) The choice to deliver shares or take a cash payoff
D) The choice of exercising the call or not

Question 14

The value of a put option at expiration is:

A) market price of the share minus the exercise price
B) higher of the exercise price minus market price of the share and zero
C) the exercise price
D) none of the above

Question 15

The owner of a regular exchange-listed put-option on the stock:

A) has the right to buy 100 shares of the underlying stock at the exercise price
B) has the right to sell 100 shares of the underlying stock at the exercise price
C) has the obligation to buy 100 shares of the underlying stock at the exercise price
D) has the obligation to sell 100 shares of the underlying stock at the exercise price

Question 16

Figure-3 depicts the:

A) position diagram for the writer (seller) of a call option
B) profit diagram for the writer (seller) of a call option
C) position diagram for the writer (seller) of a put option
D) profit diagram for the writer (seller) of a put option

Question 17

In June 2007, an investor buys a put option on Genentech stock with an exercise of price Of $75 and expiring in January 2009. If the stock price in June 2007 is $80, then this option is:
I. in-the-money
II. out-of-the-money
III. a LEAPS

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

Question 18

Figure-2 depicts the:

A) position diagram for the buyer of a call option
B) profit diagram for the buyer of a call option
C) position diagram for the buyer of a put option
D) profit diagram for the buyer of a put option

Question 19

Suppose an investor sells (writes) a put option. What will happen if the stock price on the exercise date exceeds the exercise price?

A) The seller will need to deliver stock to the owner of the option
B) The seller will be obliged to buy stock from the owner of the option
C) The owner will not exercise his option
D) None of the above

Question 20

The owner of a regular exchange-listed call-option on the stock:

A) has the right to buy 100 shares of the underlying stock at the exercise price
B) has the right to sell 100 shares of the underlying stock at the exercise price
C) has the obligation to buy 100 shares of the underlying stock at the exercise price
D) has the obligation to sell 100 shares of the underlying stock at the exercise price

Question 21

If the volatility of the underlying asset decreases, then the:

A) Value of the put option will increase, but the value of the call option will decrease
B) Value of the put option will decrease, but the value of the call option will increase
C) Value of both the put and call option will increase
D) Value of both the put and call option will decrease

Question 22

Suppose an investor buys one share of stock and a put option on the stock. What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs)

A) The value of two shares of stock
B) The value of one share of stock plus the exercise price
C) The exercise price
D) The value of one share of stock minus the exercise price

Question 23

A call option has an exercise price of $150. At the final exercise date, the stock price could be either $100 or $200. Which investment would combine to give the same payoff as the stock?

A) Lend PV of $100 and buy two calls
B) Lend PV of $100 and sell two calls
C) Borrow $100 and buy two calls
D) Borrow $100 and sell two calls

Question 24

Which of the following investors would be happy to see the stock price rise sharply?
I. Investor who owns the stock and a put option
II. Investor who has sold a put option and bought a call option
III. Investor who owns the stock and has sold a call option
IV. Investor who has sold a call option

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

Question 25

If the risk-free interest rate increases:

A) the direct effect of it on the call option price is positive
B) the direct effect of it on the call option price is negative
C) the direct effect of it on the call option price is unknown
D) none of the above

Question 26

For European options, the value of a call minus the value of a put is equal to:

A) The present value of the exercise price minus the value of a share
B) The present value of the exercise price plus the value of a share
C) The value of a share plus the present value of the exercise price
D) The value of a share minus the present value of the exercise price

Question 27

Put-call parity can be used to show:

A) How far in-the-money put options can get
B) How far in-the-money call options can get
C) The precise relationship between put and call option prices given equal exercise prices and equal expiration dates
D) That the value of a call option is always twice that of a put given equal exercise prices and equal expiration dates

Question 28

Suppose you buy a call and lend the present value of its exercise price. You could match the payoffs of this strategy by:

A) Buying the underlying stock and selling a call
B) Selling a put and lending the present value of the exercise price
C) Buying the underlying stock and buying a put
D) Buying the underlying stock and selling a put

Question 29

If the stock makes a dividend payment before the expiration date then the put-call parity is:

A) Value of call = value of put + share price - present value (PV) of dividend -PV of exercise price
B) Value of call = value of put - share price + PV of dividend - PV of exercise price
C) Value of call = value of put + share price + PV of dividend + PV of exercise price
D) Value of call = value of put + share price + PV of dividend - PV of exercise price

Question 30

Buying the stock and the put option on the stock provides the same payoff as:

A) investing the present value of the exercise price in T-bills and buying the call option
B) on the stock
C) short selling the stock and buying a call option on the stock
D) writing (selling) a put option and buying a call option on the stock
E) none of above

Question 31

For European options, the value of a call plus the present value of the exercise price is equal to:

A) The value of a put minus the value of a share
B) The value of a share minus the value of a call
C) The value of a put plus the value of a share
D) The value of a share minus the value of a put

Question 32

Given the following data: Expiration = 6 months; Stock price = $80; exercise price = $75; call option price = $12; risk-free rate = 5% per year. Calculate the price of an equivalent put option using put-call parity:

A) $3.07
B) $5.19
C) $11.43
D) none of the above

Question 33

Buying a call option, investing the present value of the exercise price in T-bills, and short selling the underlying share is the same as:

A) Buying a call and a put
B) Buying a put and a share
C) Buying a put
D) Selling a call

Question 34

The higher the underlying stock price: (everything else remaining the same)

A) higher the put price
B) lower the put price
C) has no effect on put price
D) none of the above

Question 35

Relative to the underlying stock, a call option always has:

A) A higher beta and a higher standard deviation of return
B) A lower beta and a higher standard deviation of return
C) A higher beta and a lower standard deviation of return
D) A lower beta and a lower standard deviation of return

Question 36

For European options, the value of a put is equal to:

A) The value of a call minus the value of a share plus the present value of the exercise price
B) The value of a call plus the value of a share plus the present value of the exercise price
C) The value of the share minus the value of a call plus the present value of the exercise price
D) The value of the share minus the present value of the exercise price plus the valued of a call

Question 37

The higher the underlying stock price: (everything else remaining the same)

A) higher the call price
B) lower the call price
C) has no effect on call price
D) none of the above

Question 38

Suppose an investor buys one share of stock and a put option on the stock and simultaneously sells a call option on the stock with the same exercise price. What will be the value of his investment on the final exercise date?

A) Above the exercise price if the stock price rises and below the exercise price if it falls
B) Equal to the exercise price regardless of the stock price
C) Equal to zero regardless of the stock price
D) Below the exercise price if the stock price rises and above if it falls

Question 39

Which of the following features increase(s) the value of a call option?

A) A high interest rate
B) A long time to maturity
C) A higher volatility of the underlying stock price
D) All of the above

Question 40

If the underlying stock pays a dividend before the expiration of the options that will have the following effect on the price of the options:
I. increase the value of the call option
II. increase the value of the put option
III. decrease the value of the call option
IV. decrease the value of the put option

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

Question 41

If you write a put option, you acquire the right to buy stock at a fixed strike price.

Question 42

The value of a call option is negatively related to: I) Exercise price
II) Risk-free rate
III) Time to expiration

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

Question 43

Position diagrams and profit diagrams are one and the same.

Question 44

A call options gives its owner the right to buy stock at a fixed strike price during a specified period of time.

Question 45

The value of a put option is positively related to:
I. Exercise price
II. Time to expiration
III. Volatility of the underlying stock price
IV. Risk-free rate

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

Question 46

It is possible to replicate an investment in a call option by a levered investment in the underlying asset.

Question 47

Buying a stock and a put option, and depositing the present value of the exercise price in a bank account and buying a call provide the same payoff.

Question 48

The value of a call option increases with higher volatility of the stock prices.

Question 49

For an European option: Value of call + PV(exercise price) = Value of put + share price.

Question 50

The writer of a put option loses if the stock price declines.

Question 51

The value of a call option, beyond the stock price less the exercise price, is most likely to be realized when the option is:

A) out of the money.
B) in the money.
C) at the money.
D) cannot be determined.

Question 52

The value of a put option is negatively related to:
I. stock price
II. risk-free rate III) exercise price

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

Question 53

The value of an option (both call and put) is positively related to:
I. volatility of the underlying stock price
II. time to expiration
III. risk-free rate

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

Question 54

The value of a call option is positively related to the following:
I. underlying stock price
II. risk-free rate
III. time to expiration
IV. volatility of the underlying stock price

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

Question 55

Options can have a value even when the stock is worthless.

Question 56

If the stock price follows a random walk successive price changes are statistically independent. If σ2 is the variance of daily price change, and there are t days until expiration, the variance of the cumulative price changes is:

A) σ2
B) (σ2) * (t)
C) (σ2)/t
D) none of the above

Question 57

An increase in the exercise price results in an equal increase in the call option price.

Question 58

An investor can get downside protection by buying a stock and a put option.

Question 59

An increase in the stock price results in an increase in the call option price.

Question 60

An European option gives its owner the right to exercise the option at any time before expiration.

Question 61

Briefly explain the relationship between risk and option values.

Question 62

Options written on volatile assets are worth more than options written on safer assets.

Question 63

All things being equal, the closer an option gets to expiration, the lower the option price.

Question 64

Briefly explain what is meant by put-call parity?

Question 65

Briefly explain what is meant by "protective put."

Question 66

Briefly explain how position diagrams are useful?

Question 67

Discuss the factors that determine the value of a call option.