Deck 17: An Introduction to Options

Question 1

Holders of calls do not receive the cash dividendspaid to the company's stockholders.

Answer 1

True

Question 2

A covered call is constructed by buying the stock and selling the call.

Answer 2

True

Question 3

The strike price of an option is fixed when the option is issued.

Answer 3

True

Question 4

Arbitrage determines the maximum price of an option.

Question 5

The maximum potential profit on a covered call is the time premium paid for the stock.

Question 6

Call options, unlike warrants, may be written byindividuals.

Question 7

An option's intrinsic value exceeds the option's price.

Question 8

Arbitrage is the act of simultaneously buying andselling in two markets to take advantage of price differentials.

Question 9

The intrinsic value of an option to buy stock (i.e., a call option) is the difference between the price of the stock and the per share exercise price of the option.

Question 10

As the price of a stock rises, the time premium paid for an option to buy stock increases.

Question 11

Calls are options to sell stock at a specified pricewithin a specified time period.

Question 12

If the price of an option to buy stock were to sellfor less than its strike price, an opportunity for arbitrage exists.

Question 13

The time period to expiration for call options is usually for less than a year.

Question 14

The price of an option is generally less than the option's intrinsic value.

Question 15

Because of arbitrage, an option should not sell forless than its intrinsic value.

Question 16

Investors and speculators rarely, if ever, have an opportunity to establish an arbitrage position.

Question 17

Since options offer potential leverage, they tend tosell for a time premium.

Question 18

Because of the small cash outlay to buy an option, these securities are considered to be conservative investments.

Question 19

A warrant is an option issued by a corporation to buyits stock at a specified price within a specified time period.

Question 20

The time premium paid for an option reduces the option's potential leverage.

Question 21

Writing covered call options is more risky than writing naked call options

Question 22

The intrinsic value of a put establishes the put'smaximum price.

Question 23

The buyer of a call option wants the price of the stock to rise.

Question 24

An investor may reduce risk by simultaneously purchasing a stock and a put option.

Question 25

When a call option is exercised, new stock is issued.F.23. The intrinsic value of a call option is the strike price minus the stock's price.

Question 26

The value of a put is inversely related to the value ofthe underlying stock.

Question 27

If the price of a stock rises, the writer of a putoption profits.

Question 28

In addition to put and call options on individual stocks, there are also options on the market as a whole (i.e., an index).

Question 29

Calls tend to sell for a time premium that exceeds the stock's price.

Question 30

The price of a call option is often more volatile than the price of the underlying stock.

Question 31

A writer of a naked call option will lose money if the price of the stock declines.

Question 32

The intrinsic value of a put is the price of the stockminus the put's strike price.

Question 33

There is no limit to the potential loss from buying a call option.

Question 34

The writer of a covered call cannot lose money if the price of the stock rises.

Question 35

Selling a covered call option is comparable to selling a stock short.

Question 36

A put is an option to sell stock at a specified pricewithin a specified time period.

Question 37

The profits (gains) on option trading are exempt from federal income taxation.

Question 38

The writer of a call option does not receive any dividends paid by the firm.

Question 39

The CBOE is a secondary market for put and call options.

Question 40

While individuals can write call options, they can onlybuy put options.

Question 41

If an investor constructs a covered call,

A) there is no limit to the potential profit
B) risk is increased
C) risk is reduced
D) the term of the position is increased

Question 42

If an investor anticipates that interest rates will increase, that individual should sell an option to buy Treasury bonds

Question 43

A call is an option to

A) sell stock at a specified price
B) buy stock at a specified price
C) deliver stock at a specified price
D) deliver bonds at a specified price

Question 44

Warrants are issued by

A) individuals
B) firms
C) governments
D) investor

Question 45

The most the investor who sells a naked stock indexoption can lose is the cost of the option.

Question 46

Warrants and calls do not have

A) an expiration date
B) a specified exercise price
C) the right to receive dividends
D) a strike price

Question 47

A portfolio manager with a position in many stocks may hedge the portfolio by purchasing a stock index call option.

Question 48

The intrinsic value of an option sets

A) the minimum price of an option
B) the maximum price of an option
C) neither an option's minimum nor its maximum price
D) both the maximum and the minimum price of an option

Question 49

The most the individual who buys a put option can loseis the cost of the option.

Question 50

If an investor is bearish, he or she should not buya stock index call option.

Question 51

Options to buy stock offer

A) potential leverage
B) potential income
C) safety of principal
D) liquidity

Question 52

In-the-money stock index options are not exercised.

Question 53

Buying a stock index option reduces systematic risk.

Question 54

Options sell for a time premium over their intrinsicvalue because

A) they earn dividends
B) they are debt obligations
C) they offer potential leverage
D) they are long-term investments

Question 55

Because of arbitrage, the price of an option

A) exceeds its intrinsic value
B) is less than its intrinsic value
C) cannot be less than its intrinsic value
D) cannot be greater than its intrinsic value

Question 56

The intrinsic value of an option to buy stock is

A) its price
B) its strike price
C) the difference between the stock's price and the option's strike price
D) the difference between the option's strike price and the option's price

Question 57

Stock index options permit investors to establish aposition in the market without having to select individual stocks.

Question 58

The intrinsic value of an option to buy stock rises as

A) the strike price increases and the price of the stock declines
B) the strike price increases and the price of the stock rises
C) the strike price decreases and the price of the stock declines
D) the strike price decreases and the price of the stock rises

Question 59

If the investor buys a stock index put, the individualwill profit if the market rises.

Question 60

The time premium paid for an option to buy stockis affected by

A) the length of time to expiration
B) the firm's credit rating
C) the existence of a rights offering
D) the firm's financial statements

Question 61

A warrant is the option to buy one share of stock at $40. It expires after one year and currently sells for $10. The price of the stock is $32. What is the maximum possible profit if an investor buys one share of stock and shorts one warrant What is the range of stock prices that yields a profit on this position

Question 62

A call option is similar to a warrant except

A) the strike price is fixed
B) it may be issued by individual investors
C) it is not marketable (saleable)
D) it receives dividend payments

Question 63

A put and a call have the following terms: The price of the stock is currently $55. The price of the call and put are, respectively, $9 and $1. What will be the profit from buying the call or buying the put if, after six months, the price of the stock is $40, $50, or $60

Question 64

Given the following information,
a. The intrinsic value of the call is _________.
b. The intrinsic value of the put is _________.
c. The time premium paid for the call is _________.
d. The time premium paid for the put is _________.
At the expiration of the options (i.e., after six months have lapsed), the price of the stock is $45.
e. The profit (loss) from buying the call is _______.

Question 65

Which of the following is premised on lower stock prices

A) buying a stock index call
B) buying a stock index put
C) buying a stock and selling a call
D) buying a stock and selling a put

Question 66

The writer of a naked call option wants

A) the prices of the stock and the call to rise
B) the prices of the stock and the call to fall
C) the prices of the stock to fall and the call to rise
D) the prices of the stock to rise and the call to remain stable

Question 67

The value of a put rises as the price of

A) stock rises
B) a call falls
C) stock falls
D) a call rises

Question 68

Which of the following assumes higher stock prices 1. buying a stock index call2. buying a stock index put3. selling a stock index call4. selling a stock index put

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4
PROBLEMS

Question 69

One reason for writing and selling a covered calloption is

A) potential leverage
B) safety of principal
C) income received
D) liquidity

Question 70

The CBOE is1. a secondary market in put and call options2. a division of the SEC that regulated option trading3. the first organized options exchange

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 71

If the price of a stock rises substantially,the investor who wrote a covered call1. earns a modest profit2. sustains a modest loss3. lost an opportunity for a large profit

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) only 3

Question 72

A put is an option to

A) buy stock
B) receive stock
C) sell stock
D) receive dividends

Question 73

What are the intrinsic values and time premiums of the following call options if the price of the underlying stock is $35 What are the profits and losses to the buyers and the writers if the stock sells for $31 at the options' expiration

Question 74

Stock index options1. permit the investor to short the market insteadof individual stocks2. require delivery of an index of stocks3. limit the buyer's potential loss to the cost ofthe option

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 75

Given the following information,finish the following sentences:
a. The intrinsic value of the call is _________.
b. The time premium paid for the call is ________.
c. If an investor established a covered call position, the amount invested is _________.
d. The most the buyer of the call can lose is ________.
e. The maximum amount the seller of the call naked can lose is ________.

Question 76

Call options offer buyers

A) potential leverage
B) liquidity
C) income
D) safety of principal

Question 77

The price of a call depends on1. the strike price2. the price of the underlying stock3. the term (i.e., life) of the call

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 78

What are the following call options' intrinsic values and time premiums if the price of the underlying stock is $55

Question 79

The intrinsic value of a put depends on1. the strike price2. the price of the stock3. the term on the put

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 80

A writer of a call option closes the position by

A) purchasing the stock
B) selling the stock
C) purchasing the option
D) selling the option