Question 1

It is always theoretically possible to use options as a perfect hedge against fluctuations in value of the underlying asset.

Accepted Answer

Options can be used as a perfect hedge against fluctuations in the value of the underlying asset by buying put options to hedge against a decrease in value or buying call options to hedge against an increase in value. However, practical limitations such as option premiums, timing, and execution costs may prevent the hedge from being entirely perfect.

Question 2

Risk management is the driving force behind the futures options market.

Accepted Answer

False

Question 3

The owner of a call option on a futures contract has the obligation to buy the futures contract at a predetermined strike price during a specified time period.

Accepted Answer

The owner of a call option on a futures contract has the right, but not the obligation, to buy the futures contract at a predetermined strike price during a specified time period.

Question 4

The Chicago Board Options Exchange has the largest share of stock option trading.

Accepted Answer

According to data from the Options Industry Council, the Chicago Board Options Exchange has the largest share of stock option trading in the US market.

Question 5

The standardization of option contracts and the creation of the Options Clearing Corporation are two important results of the opening of the Chicago Board of Options Exchange.

Accepted Answer

The opening of the Chicago Board of Options Exchange in 1973 led to the standardization of option contracts, making them more accessible and tradable for investors. The Options Clearing Corporation was also created to act as a central counterparty for all options trades, reducing risk for market participants.

Question 6

A portfolio containing a share of stock and a put option will have the same value as a portfolio containing a call option and the risk-free bond.

Accepted Answer

This is known as the put-call parity theorem which states that if two portfolios have the same payoff at expiration, then they must have the same value today. The formula for put-call parity is: S + P = C + X/(1+r)^t, where S is the stock price, P is the put option price, C is the call option price, X is the exercise price, r is the risk-free interest rate, and t is the time to expiration. Therefore, it is true that a portfolio containing a share of stock and a put option will have the same value as a portfolio containing a call option and the risk-free bond.

Question 7

Stock options expire on the Sunday following the third Saturday of the designated month.

Accepted Answer

Stock options typically expire on the third Friday of the expiration month, not on a Sunday.

Question 8

Index options are settled by delivery of the stocks that make up the index.

Accepted Answer

Index options are settled in cash, not by the delivery of the stocks that make up the index.

Question 9

Index options can only be settled in cash.

Accepted Answer

Index options are settled in cash based on the difference between the index value at the time of exercise and the strike price of the option. Physical delivery of the underlying asset is not possible for index options.

Question 10

The binomial model is a continuous method for valuing options.

Accepted Answer

The binomial model is a discrete method for valuing options as it assumes that the stock price can only move up or down over a given period of time.

Question 11

Investors should purchase market index put options if they anticipate an increase in the index value.

Accepted Answer

Put options are generally used to protect against a decrease in the underlying asset's value. Therefore, investors should purchase market index put options if they anticipate a decrease in the index value.

Question 12

In index options, the aggregate market takes the place of the individual stock issues being traded, as in stock options.

Accepted Answer

This statement is true. In index options, the underlying asset being traded is the aggregate market represented by an index, rather than individual stock issues.

Question 13

The most important input the investor must provide in determining option values is the strike price.

Accepted Answer

The most important input is the underlying asset's current price, as option values are primarily determined by how the current price of the asset compares to the strike price, along with volatility, time until expiration, and interest rates.

Question 14

Options on futures expire at the same time the futures contract expires.

Accepted Answer

Options on futures typically expire before the underlying futures contract expires, allowing the option holder to decide whether to exercise the option and enter into the futures position.

Question 15

The Options Clearing Corporation (OCC) acts as the guarantor of each Chicago Board Options Exchange (CBOE) traded contract.

Accepted Answer

The OCC acts as the guarantor of each Chicago Board Options Exchange (CBOE) traded contract.

Question 16

Risk management strategies involving interest rate agreements can be classified as forward-based or option-based.

Accepted Answer

This statement is true. Interest rate agreements used for risk management can either be forward agreements, which involve agreeing to a future interest rate, or option agreements, which give the holder the right but not the obligation to enter into a future interest rate agreement.

Question 17

The longer the time to expiration, the greater the value of a call option.

Accepted Answer

This is because a longer time to expiration increases the likelihood that the underlying asset will move in the desired direction, allowing the option buyer to potentially earn a profit. Additionally, a longer time to expiration provides more time for the underlying asset to reach the strike price, which can also increase the value of the option.

Question 18

Unlike stock options, futures options require the holder to enter into a futures contract.

Accepted Answer

The answer of Unlike stock options, futures options require the...

Question 19

There is an inverse relationship between the market interest rate and the value of a call option.

Accepted Answer

The value of a call option is primarily influenced by factors such as the underlying asset's price, volatility, and time to expiration, rather than directly by market interest rates. Interest rates might indirectly affect these factors, but there is no direct inverse relationship between market interest rates and the value of a call option.

Question 20

Credit risk in the options market is only a concern to the option seller.

Accepted Answer

Credit risk is a concern for both the option seller and the option buyer. The option seller is exposed to credit risk because they may not receive the payment for the option premium or may incur losses if the buyer exercises the option. On the other hand, the option buyer is exposed to credit risk because they may not receive the underlying asset if the seller defaults on their delivery obligation.

Quiz 16: Option Contracts