Question 1

The value of an interest rate call option increases when interest rates fall.

Accepted Answer

The value of an interest rate call option typically increases when interest rates rise, as the option gives the holder the right to borrow at a fixed rate, which becomes more valuable if market rates increase.

Question 2

Amy owns 100 shares of ABC stock with a cost basis of $35 a share. The stock is currently trading at $54 a share. Amy believes the price of ABC stock will fall to $45 a share in the near future but over the longer term of 3 to 5 years, increase in value to $75 a share. Amy would like to benefit from the expected near-term decline if it occurs. Therefore, Amy writes a covered call at a strike price of $55 and a premium of $2.
(a) How will the covered call help Amy profit if the expected price decline occurs?
(b) What is the maximum loss Amy can incur from the call?
(c) What is the maximum profit Amy can incur from the call?

Accepted Answer

The answer of Amy owns 100 shares of ABC stock...

Question 3

Mathew simultaneously sold a July 40 put on ZXY stock for $200 and bought a July 35 put for $75. His maximum loss is ______and his maximum gain is______ .
A) $375; $125
B) $375; unlimited
C) $500; $125
D) $275; $125

Accepted Answer

Mathew's maximum loss is the difference in strike prices minus the net premium received, which is $500 - $125 = $375. His maximum gain is the net premium received, which is $200 - $75 = $125.

Question 4

Bob's DJIA Index call option had a strike price of 261. When he exercised the option, the Dow was at 26,350.
A) Bob received $2,500 from the writer of the contract.
B) Bob paid $250 to the writer of the contract.
C) Bob received $250 from the writer of the contract.
D) Bob paid $2,500 to the writer of the contract.

Accepted Answer

The answer of Bob's DJIA Index call option had a...

Question 5

If the S&P 500 index is at 2,888, then the cash value of an S&P 500 index option is
A) $28.88.
B) $2,888.
C) $28,880.
D) $288,800.

Accepted Answer

The answer of If the S&P 500 index is at...

Question 6

ETF options are settled in
A) cash.
B) ETF shares.
C) share of the companies in the index.
D) The writer has the choice of settling in either cash or ETF shares.

Accepted Answer

The answer of ETF options are settled in
A) cash.
B) ETF...

Question 7

Long-term Equity AnticiPation Securities (LEAPS) are a form of option that gives the holder the right to buy newly issued shares of stock directly from the issuing corporation.

Accepted Answer

LEAPS are a type of option that gives the holder the right to buy or sell an existing stock at a specified price before the option expires, not to buy newly issued shares directly from the corporation.

Question 8

While stock index options can be used to play the market as a whole, they are also effective in protecting equity portfolios against falling markets.

Accepted Answer

Stock index options can be used as a hedging tool to protect equity portfolios against potential losses in a declining market by providing the option to sell at predetermined prices.

Question 9

A long straddle
A) consists of selling and writing an equal number of puts and calls with different strike prices but the same expiration date and the same underlying security.
B) is a strategy based on the expectation that the price of the underlying security will be relatively constant.
C) consists of buying a call at one strike price and then writing a call at a higher strike price.
D) is a strategy that produces profits when the price of the underlying security moves significantly in either direction.

Accepted Answer

A long straddle involves buying both a call and a put option on the same underlying security with the same strike price and expiration date. It profits from significant movements in either direction of the underlying security's price.

Question 10

Bill owns 200 shares of EG stock. In November, the market price of EG was $15.45. Bill sold two calls expiring in March with a $16 strike price on EG for $246. From November to March, EG stock price stayed at $15.45. EG paid a quarterly dividend of $0.40 per share on January 31. Over the November-March period, Bill earned
A) $80.
B) $(176).
C) $326.
D) $256.

Accepted Answer

Bill earned from two sources: the sale of call options and dividends. The call options sold for $246 total. For dividends, with 200 shares and a $0.40 per share dividend, he earned $80 ($0.40 * 200). Adding these together, $246 (from options) + $80 (from dividends) equals $326.

Question 11

The writer of a covered call has taken a(n)
A) conservative investment position with unlimited potential profits.
B) conservative investment position with limited profits.
C) aggressive position with limited losses and unlimited potential profits.
D) aggressive position with potentially unlimited profits or losses.

Accepted Answer

A covered call involves holding a long position in an asset while selling a call option on the same asset. This strategy is conservative because it limits potential profits to the premium received plus any gains up to the strike price, while the risk is reduced by owning the underlying asset.

Question 12

The premium on a stock index call would be expected to increase as the
A) market becomes more volatile.
B) option life nears expiration.
C) index price falls further below the strike price.
D) underlying securities stabilize in value.

Accepted Answer

The premium on a stock index call option is expected to increase as the market becomes more volatile because higher volatility increases the probability of the option ending in the money, thus making it more valuable.

Question 13

One could temporarily protect profits on a highly diversified portfolio of large company stocks by
I. selling S&P 500 Index put options.
II. buying S&P 500 Index put options.
III. buying S&P 500 Index call options.
IV. selling S&P 500 Index call options.
A) I and III only
B) I, II and III only
C) II and IV only
D) I, II and IV only

Accepted Answer

Buying S&P 500 Index put options can protect against a decline in the market value of a portfolio by allowing the owner to sell the index at a predetermined price, thus hedging against losses. Selling S&P 500 Index call options generates income but also obligates the seller to deliver the index at a predetermined price if the option is exercised, which can be a form of income if the seller believes the market will not rise above the strike price.

Question 14

Anthony is confident that shares of SolarTech will greatly increase in value, but thinks that it may be a year or more before that happens. He should buy
A) ETF calls.
B) LEAP puts.
C) LEAP calls.
D) Index calls.

Accepted Answer

LEAP calls are long-term options that allow the buyer to purchase a stock at a specified price within a long timeframe, often up to three years. This matches Anthony's expectation of SolarTech's shares increasing in value over a year or more, providing him with a potentially profitable investment strategy without the need to immediately purchase the stock.

Question 15

The purchase of a June call with a $25 strike price on XXO stock and the sale of a June call with a $30 strike price on XXO stock is known as a
A) long straddle.
B) short straddle.
C) vertical spread.
D) horizontal spread.

Accepted Answer

This is a vertical spread because it involves options of the same expiration date (June) but with different strike prices ($25 and $30).

Question 16

Justin owns 400 shares of ORNG stock which he bought 10 months ago at $20 per share and has now risen to $35 per share. He is afraid the stock price will fall before he has owned it for a full year, but wants to postpone realizing profits on the stock for several months, when it will become a long-term rather than short-term gain. He can protect his profit and avoid the short- term capital gains rate by
A) writing covered calls.
B) writing puts.
C) buying puts.
D) buying calls.

Accepted Answer

Buying puts allows Justin to protect his profit by giving him the right to sell his shares at a predetermined price, even if the stock price falls, without requiring him to sell his shares immediately. This strategy does not trigger a taxable event and thus postpones realizing profits until he decides to sell the shares, potentially qualifying for long-term capital gains treatment.

Question 17

Mary wrote a 40 call on ABC stock at a price of $275. She does not own any shares of ABC. Mary has
I. limited her losses to $275.
II. unlimited loss potential.
III. limited her gains to $275.
IV. unlimited profit potential.
A) I and IV only
B) II and III only
C) I and III only
D) II and IV only

Accepted Answer

Mary has unlimited loss potential because she does not own the shares (naked call), and her gains are limited to the premium received ($275).

Question 18

To exercise a call option on the Dow Jones Industrial Average, an investor would need to actually buy all 30 stocks at the strike price.

Accepted Answer

Call options on the Dow Jones Industrial Average (DJIA) are typically settled in cash, not by purchasing the actual stocks.

Question 19

A vertical spread with limited risk might involve
A) buying a call and a put on the same stock with the same strike price.
B) buying a put at a lower strike price and a call at a higher strike price.
C) buying a call at a lower strike price and writing a put at a higher price.
D) buying a call at a lower strike price and writing a call at a higher strike price.

Accepted Answer

A vertical spread with limited risk involves buying and selling options of the same class (calls or puts) with different strike prices. In choice D, buying a call at a lower strike price and writing a call at a higher strike price creates a bull call spread, which is a vertical spread with limited risk.

Question 20

The Dow-Jones Industrial Average is at 26,000. A call option on the Index with a strike price of 259 would be in the money.

Accepted Answer

The Dow-Jones Industrial Average is measured in points, not dollars, and its value is typically in the tens of thousands (e.g., 26,000 points). A call option with a strike price of 259 would not be relevant to the index's value in the tens of thousands, indicating a misunderstanding in the question's premise.

Quiz 14: Options: Puts and Calls

The value of an interest rate call option increases when interest rates fall.

Mathew simultaneously sold a July 40 put on ZXY stock for $200 and bought a July 35 put for $75. His maximum loss is and his maximum gain is .

Bob's DJIA Index call option had a strike price of 261. When he exercised the option, the Dow was at 26,350.

If the S&P 500 index is at 2,888, then the cash value of an S&P 500 index option is

ETF options are settled in

Long-term Equity AnticiPation Securities (LEAPS) are a form of option that gives the holder the right to buy newly issued shares of stock directly from the issuing corporation.

While stock index options can be used to play the market as a whole, they are also effective in protecting equity portfolios against falling markets.

A long straddle

The writer of a covered call has taken a(n)

The premium on a stock index call would be expected to increase as the

One could temporarily protect profits on a highly diversified portfolio of large company stocks by I. selling S&P 500 Index put options. II. buying S&P 500 Index put options. III. buying S&P 500 Index call options. IV. selling S&P 500 Index call options.

Anthony is confident that shares of SolarTech will greatly increase in value, but thinks that it may be a year or more before that happens. He should buy

The purchase of a June call with a $25 strike price on XXO stock and the sale of a June call with a $30 strike price on XXO stock is known as a

Mary wrote a 40 call on ABC stock at a price of $275. She does not own any shares of ABC. Mary has I. limited her losses to $275. II. unlimited loss potential. III. limited her gains to $275. IV. unlimited profit potential.

To exercise a call option on the Dow Jones Industrial Average, an investor would need to actually buy all 30 stocks at the strike price.

A vertical spread with limited risk might involve

The Dow-Jones Industrial Average is at 26,000. A call option on the Index with a strike price of 259 would be in the money.