Question 1

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.

Accepted Answer

The intrinsic value of a call option is the difference between the stock price and the strike price of the option. This is because a call option gives the holder the right to purchase the stock at the strike price, so if the stock is currently trading at a higher price than the strike price, the option has intrinsic value.

Question 2

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

Accepted Answer

The price of an option (its premium) can be equal to or greater than its intrinsic value because it also includes time value, which accounts for the potential of the option to gain in value before expiration.

Question 3

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

Accepted Answer

This is true as the cash dividends are paid to the holders of the company's stock and not to the holders of calls, who only have the option to buy the stock at a predetermined price.

Question 4

Arbitrage determines the maximum price of an option.

Accepted Answer

Arbitrage involves exploiting price differences of the same asset in different markets or forms, but it does not determine the maximum price of an option. Option pricing is influenced by factors such as the underlying asset's price, volatility, time to expiration, and interest rates, typically modeled using techniques like the Black-Scholes formula.

Question 5

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

Accepted Answer

This is the definition of arbitrage.

Question 6

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

Accepted Answer

An option's intrinsic value is the part of the option's price that can be realized if the option is exercised immediately. It does not exceed the option's total price, which also includes time value and possibly other components.

Question 7

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

Accepted Answer

Call options typically have expirations of less than a year, although some can have expirations of up to two or three years.

Question 8

Call options, unlike warrants, may be written by
individuals.

Accepted Answer

Call options can be written by individuals who are willing to sell their underlying asset at a predetermined price in the future. Warrants, on the other hand, are typically issued by the company and cannot be written by individuals.

Question 9

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

Accepted Answer

This is the correct definition of a warrant.

Question 10

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

Accepted Answer

The answer of Investors and speculators rarely, if ever, have...

Question 11

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

Accepted Answer

Arbitrage refers to the practice of making a risk-free profit by simultaneously buying and selling the same or similar assets in different markets. In the case of options, if an option is priced lower than its intrinsic value, arbitrageurs can buy the option and simultaneously sell the underlying asset, locking in a profit. This buying pressure would drive up the price of the option until it reaches its intrinsic value, preventing it from selling for less than its intrinsic value.

Question 12

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

Accepted Answer

Options can be very risky investments, as they involve the potential for loss of the entire premium paid for the option.

Question 13

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

Accepted Answer

A covered call involves owning the underlying stock and selling a call option against it. This strategy can generate income for the option seller, but also limits their potential profit if the stock price rises above the call's strike price.

Question 14

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

Accepted Answer

Calls are options to buy stock at a specified price within a specified time period.

Question 15

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

Accepted Answer

The answer of As the price of a stock rises,...

Question 16

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

Accepted Answer

The price of an option (premium) is not directly compared to its strike price for arbitrage opportunities. Arbitrage involves exploiting price differences of the same asset across different markets or forms. The option's price is determined by factors like the underlying stock's price, volatility, time to expiration, and the strike price, not just the strike price alone.

Question 17

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

Accepted Answer

The maximum potential profit on a covered call is achieved when the stock price rises to or above the strike price of the call option sold. It is the sum of the premium received for selling the call and the gain in the stock price up to the strike price, not just the time premium paid for the stock.

Question 18

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

Accepted Answer

Options offer potential leverage as the investor has the right to buy or sell an underlying asset at a certain price within a specific time period. This potential for higher returns leads to options selling for a time premium, which is the amount an investor pays for the right to buy or sell the asset.

Question 19

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

Accepted Answer

The time premium is the amount paid for the option that reflects the time remaining until expiration. The longer the time remaining, the higher the time premium will be. The time premium reduces the option's potential leverage because it increases the cost of the option, making it more expensive to purchase and therefore reducing the potential return on investment.

Question 20

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

Accepted Answer

The strike price, also known as the exercise price, is the price at which the buyer of an option can buy or sell the underlying asset. It is agreed upon at the time the option is issued and remains fixed throughout the option's lifespan.

Quiz 17: An Introduction to Options

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.

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

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

Arbitrage determines the maximum price of an option.

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

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

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

Call options, unlike warrants, may be written by individuals.

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

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

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

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

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

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

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

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

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

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

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

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