Question 1

A put option is "out of the money" when the

Accepted Answer

A put option is considered "out of the money" when the market price of the underlying security is higher than the option's strike (exercise) price, making it unfavorable to exercise the option.

Question 2

The ____, the higher the call option premium, other things being equal.

Accepted Answer

The longer the maturity of the option, the higher the call option premium, as there is more time for the underlying asset's price to increase.

Question 3

Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4 premium per share. The pension fund sells a call option on the stock it owns. If the calloption is exercised when the price of the stock is $56, what is the gain or loss per share to the pension fund (including its gain from holding the stock as well)?

Accepted Answer

The pension fund bought the stock at $53 and sold a call option with a $4 premium. If the stock price rises to $56 and the option is exercised, the fund sells the stock at the $50 exercise price. The total income from the option is the $4 premium plus the $50 from selling the stock, totaling $54. Since the fund initially bought the stock at $53, the net gain is $1 per share ($54 - $53).

Question 4

Put options are typically used to hedge when portfolio managers are mainly concerned about

Accepted Answer

Put options are contracts that give the holder the right, but not the obligation, to sell an underlying asset (such as a stock) at a specified price (strike price) within a specified period (expiration date). Therefore, they are typically used as a hedging tool to protect against a temporary decline in a stock's value, rather than a permanent decline or increase. Portfolio managers may purchase put options to offset potential losses in their portfolio in the event of a short-term market downturn.

Question 5

The sale of a call option on a stock the seller already owns is referred to as

Accepted Answer

Selling a call option on a stock that the seller already owns is known as a covered call. This strategy is often used by investors to generate income from their stock holdings, as the seller is essentially betting that the stock price will not rise above the strike price of the call option. This strategy is considered to be less risky compared to selling naked calls because of the underlying stock ownership.

Question 6

A speculator purchases a put option on Treasury bond futures with a September delivery date with an exercise price of 85-00. The option has a premium of 2-00. Assume that the price of the futurescontract decreases to 82-00 on the expiration date and the option is exercised at that point (if it is feasible). What is the net gain?

Accepted Answer

The answer of A speculator purchases a put option on...

Question 7

Sellers (writers) of call options can offset their position at any point in time by

Accepted Answer

The answer of Sellers (writers) of call options can offset...

Question 8

A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.

Accepted Answer

A call option is a contract that gives the owner the right, but not the obligation, to buy a specified financial instrument for a specified price within a specified period of time. The specified price is known as the strike price. Therefore, the owner of a call option has the right to exercise the option and buy the underlying asset at the strike price, regardless of its current market price, within the specified time period.

Question 9

The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option premium.

Accepted Answer

Higher volatility increases the potential for movement in the stock price, which increases the value of both call and put options, as both types of options benefit from greater movement in the underlying stock's price.

Question 10

A ____ requires a premium above and beyond the price to be paid for the financial instrument.

Accepted Answer

Both call options and put options require a premium to be paid above and beyond the price of the underlying asset. Futures contracts, on the other hand, do not require a premium but may require a margin deposit.

Question 11

The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.

Accepted Answer

The OCC serves as a central counterparty and provides clearing and settlement services for options traded on U.S. exchanges. As a result, it acts as a guarantor for fulfillment of the contractual obligations of both sides of an options trade.

Question 12

A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29 and rises to $32 before the expiration date. What is the stock priceat which the speculator would break even?

Accepted Answer

To break even on a put option, the stock price must be below the exercise price by at least the amount of the premium paid. Here, the exercise price is $30, and the premium is $4, so the break-even stock price is $30 - $4 = $26.

Question 13

A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. What is the stock price at which the speculator would break even?

Accepted Answer

The break-even point for a call option is calculated by adding the premium paid for the option ($3) to the exercise price ($50). Therefore, the break-even stock price is $53.

Question 14

The ____ is the most important exchange for trading options.

Accepted Answer

The Chicago Board Options Exchange (CBOE) is the largest and most important exchange for trading options. It was the first exchange to offer standardized options trading, and it continues to be the leader in the options market, offering a wide range of options contracts on a variety of underlying assets. The NYSE and NYSE MKT primarily focus on stock trading, while the Boston Options Exchange has lower trading volume than the CBOE.

Question 15

A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29 and rises to $32 before the expiration date. What is the maximum profit per unit to the speculator who owned the put option assuming he or she exercises the option at the ideal time?

Accepted Answer

The answer of A speculator purchases a put option for...

Question 16

Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a premium of 14, with an exercise price of 1800. The value of an S&P 500 futures contract is 250 timesthe index. If the index on the futures contract increases to 1830, what is the gain on the sale of the futures contract?

Accepted Answer

The insurance company purchased a call option on an S&P 500 index futures contract for a premium of 14. If the index on the futures contract increases to 1830 and the exercise price is 1800, the insurance company can exercise the call option and purchase the futures contract for 1800. The value of the futures contract would be 250 times the index, which is $457,500 (1830 x 250). If the insurance company sells the futures contract at this price, they will have a gain of $457,500 - $180,000 (exercise price + premium) = $277,500. However, we must subtract the premium of $14 from the gain, resulting in a net gain of $277,486. Therefore, the answer is D, $4,000.

Question 17

When the market price of the underlying security exceeds the exercise price, a

Accepted Answer

When the market price of the underlying security exceeds the exercise price, the call option has a positive value and can be exercised for a profit. This is known as being "in the money." A put option is in the money when the market price of the underlying security is below the exercise price. Being "at the money" means the market price of the underlying security is the same as the exercise price, and being "out of the money" means the option has no intrinsic value.

Question 18

____ execute transactions desired by investors and trade stock options for their own account.

Accepted Answer

Market makers execute transactions desired by investors by buying and selling securities for their own account. This helps ensure there is a liquid market for the security, as the market maker is always available to buy or sell at a quoted price. Floor brokers execute orders on behalf of clients on the exchange floor, while discount brokers offer lower-cost trades but do not typically provide market-making services.

Question 19

The longer the time to maturity, the ____ the call option premium and the ____ the put option premium.

Accepted Answer

The answer of The longer the time to maturity, the...

Question 20

Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.

Accepted Answer

Covered call writing involves selling call options on a stock that the seller already owns. This strategy generates income from the option premiums but limits the upside potential because if the stock price rises above the strike price of the call, the stock may be called away. However, it decreases the risk because the income from the option premium provides some downside protection.

Quiz 14: Options Markets