Deck 24: Options

Question 1

Profits ~earnedon a six month call option are treated as

A) interest income.
B) short-term capital gains.
C) dividend income.
D) nontaxable income.

Answer 1

B

Question 2

The price of an option contract paid to the writer is known as the

A) commission
B) percentage spread
C) premium
E) exercise price

Answer 2

C

Question 3

An American option can be exercised

A) only on its expiration date.
B) at any central security exchange.
C) anytime during its life.
D) only when the stock pays dividends.

Answer 3

C

Question 4

The Black-Scholes formula calculates the fair value of an option assuming no

A) taxes nor transaction costs
B) time remaining before expiration
C) risk free rate of return
D) stock volatility

Question 5

The _____ option pricing model is predicated on the assumption that stock prices can move to only two values over a short period of time.

A) call
B) arbitrage
C) binomial
D) indexed

Question 6

A call option specifies all but

A) the date the option expires.
B) the striking price.
C) the intrinsic value of the shares.
D) the company whose shares can be purchased.

Question 7

The intrinsic value of an option is the value if it were exercised

A) immediately
B) only at the expiration date
C) out-of-the money
D) in-the-money

Question 8

A ___ option gives the buyer the right to purchase a specific number of shares of a specific company from the writer at a specific purchase price by a specific date.

A) put
B) call
C) stock index
D) swap

Question 9

The term ____ indicates that the option writer does not own the underlying stock on which the option is written.

A) off-cover
B) naked
C) covered call writing
D) European option

Question 10

The organization that guarantees the delivery of stock if an option is exercised is the

A) SEC.
B) OTC.
C) SIPC.
D) NASDAQ.

Question 11

One limitation to the Black-Scholes model is that strictly speaking it is only applicable to options that do not

A) have an expiration date
B) pay dividends over the life of the option
C) display implied volatility
D) have an intrinsic value

Question 12

For an option, the exercise price is also called the

A) striking price.
B) booking price.
C) market value.
D) spot price.

Question 13

The market that is a zero-sum game is the

A) common stock.
B) preferred stock.
C) options.
D) Treasury bill.

Question 14

An option is a type of contract between a buyer and a writer wherein one grants the other the __ to buy or sell a specific asset at a specific price within a specified date.

A) right
B) obligation
C) tax status
D) power of attorney

Question 15

The relationship between the market price of a put and a call that have the same exercise price, expiration date, and underlying stock is known as _____ parity.

A) forward rate
B) buy-sell
C) interest rate
D) put-call

Question 16

The purchaser of a call option feels that the stock will

A) pay a large dividend.
B) maintain a level price.
C) have a drop in price.
D) have a price rise.

Question 17

For a put option, the kink in the intrinsic value curve occurs at the

A) premium price.
B) exercise price.
C) value of $0.
D) value of strike price - market price.

Question 18

___ is an investment strategy designed to earn a minimum rate of return while allowing the investor to benefit substantially from the positive returns generated by an investment in a risky portfolio.

A) Counterparty risk
B) Naked put writing
C) Covered call writing
D) Portfolio insurance

Question 19

Trading on option exchanges involves a person, known as the _____, who facilitates the trading of financial assets by maintaining an inventory in particular securities

A) specialist
B) floor trader
C) floor broker
E) market maker or dealer

Question 20

An option not written on an individual issue of common stock is known as a(n) ____ option.

A) European
B) American
C) index
D) call

Question 21

A put option does not specify the

A) number of shares that can be sold.
B) exercise price.
C) premium on the put option.
D) company whose shares can be sold.

Question 22

Using the Black-Scholes model to value a call option shows that when the other four variables are held fixed, the option price will be higher if the

A) price of the stock rises.
B) time to maturity is shorter.
C) exercise price is higher.
D) riskfree rate is lower.

Question 23

Using the Black-Scholes model and all other input variables are held constant, the value of a put will decline if the

A) higher the risk of the common stock.
B) lower the riskfree rate.
C) lower the exercise price.
D) lower the price of the stock.

Question 24

A share sells for $40, and its call option sells for $4. The hedge ratio is .8 and the share price rises by 10%. The call option price should

A) fall by 20%.
B) rise by 80%.
C) rise to $4.80.
D) fall by $3.20.

Question 25

To determine a stock's implicit volatility involves

A) using a 10-year history of Value-Line industry data.
B) solve for the logarithm of the Wall Street Journal daily stock yields.
C) taking the range of the option price divided by two.
D) solving the Black-Scholes for the standard deviation.

Question 26

The hardest value to estimate for the Black-Scholes model is the

A) riskfree rate.
B) exercise price.
C) present market price of the stock.
D) risk of the stock.

Question 27

The higher the amount of dividends a stock pays, the

A) the lower its dividend yield.
B) the higher the value of a call option.
C) the value of a call will increase immediately after the ex-dividend day.
D) the lower the value of a call option.

Question 28

To use the Black-Scholes model to value a call option, you do not need the

A) length of time until the option expires.
B) riskfree rate.
C) hedge ratio.
D) market price of the stock.

Question 29

For the Black-Scholes model, the stock's risk should be stated on a basis that is

A) same as the expiration period.
B) annual.
C) weekly.
D) daily.

Question 30

A put option is out of the money if the

A) expiration date is more than six months.
B) market price is greater than the exercise price.
C) the stock declares a dividend.
D) market and exercise prices are equal.

Question 31

Organized exchanges for options trading began in

A) 1945.
B) 1933.
C) 1973.
D) 1954.

Question 32

The purchaser of a put option expects the stock price to

A) fall.
B) double.
C) remain level.

Question 33

The exercise price and number of shares of an option are unaffected by

A) a reverse stock split.
B) payment of a cash dividend.
C) a 5 for 1 split.
D) a stock dividend.

Question 34

Within an options listing, the letter r indicates the option

A) also provides a rights offering.
B) wasn't traded.
C) does not require a premium
D) is ex-dividend.

Question 35

A put warrant gives the owner the right to

A) sell future dividends.
B) sell the index.
C) sell a group of warrants.
D) buy a specified stock.

Question 36

Listed options expire

A) at midnight of the second Thursday of the specific month.
B) at noon on December 31.
C) every Friday at 4:00 p.m.
D) on Saturday after the third Friday of a specified month. (e) at no specified time.

Question 37

It may be advantageous to exercise a put option

A) early if it is in the money.
B) early if it is out of the money.
C) only on the expiration date.
D) if the price of the put is below the intrinsic value.

Question 38

As compensation for the risk of an option writer, the option purchaser will pay

A) a commission.
B) a cash dividend.
C) an intrinsic value.
D) a premium.

Question 39

The basic Black-Scholes option valuation considers the effects of

A) the exercise price of the option.
B) tax expense.
C) cash dividend payments.
D) continuous buying and selling the option.

Question 40

IRX options are options on

A) municipal bond rates.
B) short-term Treasury rates.
C) the prime rate.
D) dividend yields.

Question 41

Buying and selling a call option on the same stock with the same strike price and expiration date is a

A) strip.
B) straddle.
C) spread.
D) split.

Question 42

Which one of the following options would be associated with the MOST risk for the writer if the underlying stock is expected to increase substantially before expiration?

A) a call
B) a put
C) a naked put
D) a naked call

Question 43

If a writer sells a put with a strike price of $70 at $3 per share, what is his profit or loss if the underlying stock at expiration is selling at $72?

A) $4
B) $3
C) -$3
D) -$4

Question 44

Using the BOPM, if a call is overpriced, an investor would

A) buy a call.
B) not participate in the market.
C) buy a call and buy a bond.
D) write a call.

Question 45

The Option Clearing Corporation created the ______ system to protect itself from the actions of the writers.

A) margin
B) commission
C) order book
D) option pricing

Question 46

The writer of a naked call option needs to provide the brokerage firm with

A) an amount based on the premium, strike price, and market value.
B) the amount of the premium.
C) nothing.
D) 100 shares of the underlying stock.

Question 47

You own a call option with a strike price of $40 and a stock market price of $46. The intrinsic value of the call is

A) $ 6
B) $40.
C) $46.
D) -$6.
E)$ 0.

Question 48

A method that would not protect an investor from a loss if the market value of his portfolio fell would be

A) stop order.
B) sell a put option.
C) create a synthetic put.
D) buy an insurance policy.

Question 49

A put option gives the owner the

A) obligation to sell shares.
B) right to buy shares.
C) right to sell shares.
D) right to buy or sell shares.

Question 50

The margin requirements for index options are

A) more than for individual stock put options.
B) not required.
C) based on Treasury bill rates.
D) less than for individual stock options.
DIFFICULT

Question 51

A replicating portfolio for a call option includes .75 share of stock. The hedge ratio states that for each $1 decline in the stock price, the price of the call should

A) decline by $.75.
B) rise by $1.
C) decline by S.25.
D) rise by $.25.

Question 52

At the CBOE, options trading is

A) through open outcry.
B) from a closed order book.
C) done only at the hour mark.
D) all done through computer matching.

Question 53

The owner of a three month call option allows the option to expire unexercised. The owner

A) has a capital loss equal to the market price of the stock.
B) has a capital loss equal to the strike price.
C) has a capital loss equal to the premium.
D) has a capital loss equal to the market value less the strike price.

Question 54

Using the BOPM to analyze a call option on a monthly basis would result in a total number of possible year-end stock prices of

A) 12.
B) 2.
C) 24.
D) 13.

Question 55

A(n) ____ will increase the market value of a call option.

A) decrease in the announced dividend amount
B) decrease in the time to expiration
C) decrease in the volatility of the underlying stock
D) increase in the interest rate

Question 56

The percentage of the premium that the buyer of a call option is allowed to borrow through margin is

A) 50.
B) 0.
C) 33.
D) 80.

Question 57

A(n) ____ will increase the market value of a put option.

A) interest rate change
B) increase in the dividend rate of the underlying stock
C) decrease in the volatility of the underlying stock
D) decrease in the earnings rate of the underlying stock

Question 58

If a writer sells a naked call option with an exercise price of $100 at $9 per share, what is her profit or loss at expiration is the stock is selling at $115?

A) $5
B) -$5
C) -$6
D) -$10

Question 59

If an investor buys a call with a strike price of $90 and the underlying stock at the time of expiration is $96, what is her profit or loss per share if she paid the writer $4 a share?

A) $2
B) $1
C) -$1
D) -$2

Question 60

Program trading is a form of

A) portfolio insurance.
B) profit maximization.
C) passive maintenance.
D) minimizing transaction costs.

Question 61

You write a naked call for March 30; premium of $5 per share; market value per share of $46. Your margin requirement would be

A) $1,000.
B) $ 400.
C) $2,500.
D) $1,100.

Question 62

Suppose an investor buys a put for $2.50 a share which matures in 3 months with a strike price of $50. What is the rate of return if the stock price falls to $46 on the expiration date?

A) 40%
B) 50%
C) 55%
D) 60%

Question 63

A writer sells a covered call at $3 per share with a strike price of $65. If the stock price rises to $71 at expiration, what is the profit or loss to the writer?

A) $6
B) $2
C) -$2
D) -$6

Question 64

Due to the limitations of the Black-Scholes option pricing model, it is least problematic to value

A) American options on dividend-paying stocks
B) American options on non-dividend paying stocks
C) European options on dividend-paying stocks
D) either American or European options regardless of the dividend payments

Question 65

You can buy a $100 share that will be worth either $120 or $70 in one year, a $100 bond that will be worth $107 in one year, or a call option for the stock for $10. Developing a replicating portfolio with the BOPM, the proportion of the portfolio in the stock should be

A) 40%.
B) 20%.
C) 60%.
D) 100%.

Question 66

In the Black-Scholes option pricing model, an increase in a stock's volatility (all else being constant)

A) increases the associated call option value
B) decreases the associated call option value
C) may decrease or increase the option value, depending on the level of interest rates
D) does not change either the put or call option value because put-call parity holds

Question 67

An important assumption of put-call parity is that

A) both options may have different exercise prices but the same expiration dates
B) both options have the same exercise prices and the same expiration dates
C) both options will produce the same payoff on the stock as well as a risky bond
D) both options will produce the same payoff on the stock as well as another risky asset.

Question 68

According to the Black-Scholes option pricing model, there is an inverse relationship between the value of a call and

A) the risk-free interest rate
B) time remaining before expiration
C) the risk of the underlying stock
D) the exercise price of the call

Question 69

You write a naked put option of June 20, premium of $3 per share, market price per share of $21. Your margin requirement is

A) $ 620.
B) $2,000.
C) $1,000.
D) $ 100.