Question 1

Option values increase with the length of time to maturity. The expected change in the option premium from a small change in the time to expiration is termed delta.

Accepted Answer

The expected change in the option premium from a small change in the time to expiration is termed theta, not delta. Delta measures the sensitivity of the option price to changes in the price of the underlying asset.

Question 2

For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an increase in the foreign interest (the pound sterling rate) rate from 8% to 9% - the new option premium would be:

Accepted Answer

The phi value indicates the sensitivity of the option's price to changes in the foreign interest rate. A phi of -0.2 means that for a 1% increase in the interest rate, the option premium decreases by 0.2%. With a 1% increase in the interest rate, the premium decreases by 0.2% of $0.033/£, resulting in a new premium of approximately $0.031/£.

Question 3

The sensitivity of the option premium to a small change in the spot exchange rate is called the gamma.

Accepted Answer

The sensitivity of the option premium to a small change in the spot exchange rate is called the delta, not the gamma. Gamma measures the rate of change of delta.

Question 4

The Theta of an option is defined as:

Accepted Answer

Theta measures the expected change in the option premium for a small change in time to expiration. It is also known as the time decay of an option.

Question 5

A trader who is buying options of longer maturities will pay more, and proportionately more, for the longer maturity options.

Accepted Answer

The answer of A trader who is buying options of...

Question 6

The Rho of an option is defined as:

Accepted Answer

Rho measures the expected change in the option premium for a small change in the domestic interest rate.

Question 7

The Phi of an option is defined as:

Accepted Answer

Phi in options trading refers to the sensitivity of an option's price to a change in the foreign interest rate. It measures how much the price of an option is expected to change with a 1% change in the foreign interest rate, holding other factors constant.

Question 8

The Lambda of an option is defined as:

Accepted Answer

Lambda is the option's sensitivity to volatility. It is defined as the expected change in the option premium for a small change in volatility. It is also known as the Vega of an option.

Question 9

If an American-style option possesses time value on any day up to expiration date, the option holder would get more by selling it than exercising it.

Accepted Answer

This is because if the option possesses time value, then there is still potential for its price to increase before expiration. Therefore, selling the option would allow the holder to realize the time value and potentially make more money than if they simply exercised the option.

Question 10

The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).

Accepted Answer

The answer of The time value is asymmetric in value...

Question 11

For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an increase in the U.S. dollar rate from 8% to 9% - the new ATM option premium would be:

Accepted Answer

The answer of For a $1.50/£ call option with an...

Question 12

Option volatility is defined as the square root of the standard deviation of daily percentage changes in the underlying exchange rate.

Accepted Answer

Option volatility, often referred to as implied volatility, measures the market's expectation of the future volatility of the option's underlying asset. It is not defined as the square root of the standard deviation of daily percentage changes in the underlying exchange rate, but rather inferred from the market price of the option itself.

Question 13

The majority of the option premium is lost in the final days prior to expiration.

Accepted Answer

This is because as the expiration date approaches, the time value of the option decreases, resulting in a lower premium. This phenomenon is known as time decay.

Question 14

As long as the option has time remaining before expiration, the option will possess time the time value element.

Accepted Answer

This statement is true. Time value is one of the components that make up an option's premium, and it represents the amount of time remaining before the option expires. As the option approaches expiration, the time value will decrease until it eventually reaches zero at expiration.

Question 15

The Delta of an option is defined as:

Accepted Answer

The Delta of an option measures the expected change in the option premium for a small change in the spot rate, which is the current market price of the underlying asset. The other options listed are known as other Greeks, including Theta (A), Vega (B), and Rho (D), which measure the impact of changes in time to expiration, volatility, and interest rates, respectively, on the option premium.

Question 16

Standard foreign currency options are priced around the forward rate.

Accepted Answer

Standard foreign currency options are priced using the Black-Scholes model, which assumes that the underlying asset follows a lognormal distribution and that the option is exercised at expiration. The model uses the forward rate as one of its inputs, which means that the option's price is directly related to the forward rate. Therefore, we can say that options are priced around the forward rate.

Question 17

Which of the following statements is NOT true about currency option pricing sensitivities?

Accepted Answer

Increases in domestic interest rates typically cause increasing call option premiums due to the potential for higher returns from the underlying asset.

Question 18

If the rho of the specific option is known, it is easy to determine how the option's value will change as the spot rate changes.

Accepted Answer

Rho measures the sensitivity of an option's price to changes in interest rates, not the spot rate. The spot rate's impact on an option's value is more directly related to the Delta and Gamma of the option.

Question 19

The higher the delta the greater the probability of the option expiring in-the-money.

Accepted Answer

Delta is a measure of how much the option price will change in relation to changes in the underlying asset price. It ranges from 0 to 1 for call options (and -1 to 0 for put options) and indicates the probability of the option expiring in-the-money. Options with higher delta values are more sensitive to changes in the underlying asset price and have a greater chance of ending up in-the-money at expiration.

Question 20

The value of any option that is currently in-the-money (ITM) is made up entirely of time value.

Accepted Answer

The value of an ITM option is made up of both intrinsic value (the difference between the current stock price and the option's strike price) and time value (the potential for the option to further increase in value before expiration).

Quiz 7: Foreign Currency Derivatives: Futures and Options