Question 1

You sold ten put option contracts on PLT stock with an exercise price of $31.20 and an option price of $1.20. Today,the option expires and the underlying stock is selling for $33 a share. Ignoring trading costs and taxes,what is your total profit or loss on this investment?

Accepted Answer

Since the stock price at expiration ($33) is above the exercise price ($31.20), the put options expire worthless. You keep the premium received from selling the options, which is $1.20 per share. For 10 contracts (1,000 shares), the total premium is $1,200, which is your profit.

Question 2

You sold a put contract on EDF stock at an option price of $.50. The option had an exercise price of $21. The option was exercised. Today,EDF stock is selling for $20 a share. What is your total profit or loss on all of your transactions related to EDF stock assuming that you close out your positions in this stock today? Ignore transaction costs and taxes.

Accepted Answer

When you sold the put contract at an option price of $.50, you collected a premium of $.50 per share or $50 in total (100 shares x $.50). If the option was exercised, you would have to buy 100 shares of EDF stock at the exercise price of $21 per share, costing you $2,100 in total. However, since the stock is currently trading at $20 per share, you would have a loss of $100 if you sold the stock immediately after buying it. Therefore, your total loss would be $100 (loss on stock) - $50 (premium collected) = -$50.

Question 3

Several rumors concerning Wyslow,Inc. stock have started circulating. These rumors are causing the market price of the stock to be quite volatile. Given this situation,you decide to buy both a one-month put and a one month call option on this stock with an exercise price of $15. You purchased the call at a quoted price of $.40 and the put at a price of $2.30. What will be your total profit or loss on these option positions if the stock price is $4 on the day the options expire?

Accepted Answer

The answer of Several rumors concerning Wyslow,Inc. stock have started...

Question 4

Suppose XYZ is priced at $125 a share,has a call with an exercise price of $150,has two months to expiration,and costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call that is so far out of the money?

Accepted Answer

The answer of Suppose XYZ is priced at $125 a...

Question 5

Suppose you look in the newspaper and see ABC trading at $50 per share. Calls on ABC with one month to expiration and an exercise price of $45 are trading at $6.50 each. Puts on ABC with one month to expiration and an exercise price of $55 are trading at $3.50 each. Are these prices reasonable?
 Explain. (Ignore transactions costs.)

Accepted Answer

The answer of Suppose you look in the newspaper and...

Question 6

You purchased six TJH call option contracts with a strike price of $40 when the option was quoted at $2. The option expires today when the value of TJH stock is $43. Ignoring trading costs and taxes,what is your total profit or loss on your investment?

Accepted Answer

Each contract represents 100 shares, so you have purchased 6 contracts representing 600 shares.
The cost of buying the contracts was:
$2 x 100 shares x 6 contracts = $1,200
The strike price of the option is $40, and the stock price at expiration is $43, so the option is in-the-money by $3.
The profit per share is $3 - $2 = $1.
So, the total profit is:
$1 x 100 shares x 6 contracts = $600.

Question 7

Three months ago,you purchased a put option on WXX stock with a strike price of $61 and an option price of $.60. The option expires today when the value of WXX stock is $63.50. Ignoring trading costs and taxes,what is your total profit or loss on your investment?

Accepted Answer

When you buy a put option, you are hoping that the stock price will decrease, giving you the opportunity to sell at a higher price than the market value. In this case, as the stock price is higher than the strike price of the put option, you would not exercise the option to sell at $61. Thus, you would lose the option price of $.60, resulting in a loss of $60.

Question 8

How do options apply to capital budgeting?
 Explain and give an example.

Accepted Answer

The answer of How do options apply to capital budgeting?
...

Question 9

Suppose your wealthy Aunt Minnie has asked you to manage her large stock portfolio. You would like to buy and/or sell options on many of the stocks she owns. Describe the types of options you would buy or sell,as well as your rationale,given the following circumstances:
a. Aunt Minnie owns 10,000 shares of IBM common stock. You believe it is going to fall in price,but she won't let you sell it because her late husband told her never to let it go. How do you protect her from the impending price decline?
b. Your analysis suggests that the common stock of Jet-Electro is poised to increase in value sharply over the next year. Aunt Minnie doesn't want to buy any of the stock,but does want you to use options to profit if the price rises. What do you do?
c. Although Aunt Minnie doesn't want you to sell any of the stocks she owns,she would like you to use options to generate a little extra income. How might you do this?
Looking at each option,we see:

Accepted Answer

The answer of Suppose your wealthy Aunt Minnie has asked...

Question 10

You wrote ten call option contracts on JIG stock with a strike price of $41 and an option price of $.60. What is your net gain or loss on this investment if the price of JIG is $46.05 on the option expiration date?

Accepted Answer

The answer of You wrote ten call option contracts on...

Question 11

The current market value of the assets of ABC,Inc. is $86 million. The market value of the equity is $43.28 million. What is the market value of the firm's debt?

Accepted Answer

Market value of firm's assets = $86 million
Market value of the equity = $43.28 million

Market value of debt = Market value of assets – Market value of equity
Debt = $86 million – $43.28 million
Debt = $42.72 million

Therefore, the answer is C) $42.72 million.

Question 12

Explain the rationale behind the statement that equity is a call option on the firm's assets. When would a shareholder allow the call to expire?

Accepted Answer

The answer of Explain the rationale behind the statement that...

Question 13

You purchased four WXO 32 call option contracts at a quoted price of $.34. What is your net gain or loss on this investment if the price of WXO is $35 on the option expiration date?

Accepted Answer

The answer of You purchased four WXO 32 call option...

Question 14

What are the upper and lower bounds for an American call option?
 Explain what would happen in each case if the bound was violated.

Accepted Answer

The answer of What are the upper and lower bounds...

Question 15

The market price of ABC stock has been very volatile and you think this volatility will continue for a few weeks. Thus,you decide to purchase a one-month call option contract on ABC stock with a strike price of $25 and an option price of $1.50. You also purchase a one-month put option on ABC stock with a strike price of $25 and an option price of $.70. What will be your total profit or loss on these option positions if the stock price is $24.60 on the day the options expire?

Accepted Answer

The call option will expire worthless, resulting in a loss of $1.50. The put option will be in-the-money by $0.40, resulting in a profit of $40. Total profit/loss = -$1.50 + $40 = -$1.80.

Quiz 22: Options and Corporate Finance