Exam 17: An Introduction to Options

A call option is similar to a warrant except

Arbitrage determines the maximum price of an option.

The intrinsic value of an option to buy stock (i.e., a call option)is the difference between the price of the stock and the per share exercise price of the option.

What are the intrinsic values and time premiums of the following call options if the price of the underlying stock is $35? What are the profits and losses to the buyers and the writers if the stock sells for $31 at the options' expiration?            Strike Price         Price of the Option              $30                          $7.50              $35                         $3.00

You obtain the following information concerning a stock, a call option, and a put option: ​     Price of the stock                 $42     Strike price (both options)  $40     Price of the call                    $6     Price of the put                     $3     Expiration date           three months ​ You want to purchase the stock but also want to use an option to reduce your risk of loss. ​ a. Do you purchase the put or the call, or do you sell the put or the call? ​ b. What is the cash inflow or outflow from your position? ​ c. What is the profit or loss if the price of the stock stagnates and trades for $42 after three months? ​ d. What is the profit or loss if the price of the stock trades for $50 or $100 after three months? ​ e. What is the profit or loss if the price of the stock trades for $30 after three months? ​ f. What is the worst case scenario? ​ g. If you want to retain the position, what must be done after three months have passed?

The intrinsic value of an option sets

The profits (gains)on option trading are exempt from federal income taxation.

A put is an option to

The CBOE is 1. a secondary market in put and call options 2. a division of the SEC that regulates option trading 3. the first organized options exchange

A three-month call option with a strike price of $30 is currently selling for $4 when the price of the underlying stock is selling for $32. ​ a. What is the call's intrinsic value? ​ b. What is the time premium? ​ c. What is the maximum possible loss to the buyer of the call? ​ d. What is the maximum possible profit to the seller of the option? ​ e. Would you buy the call if you expected the price of the stock to fall? ​ Three months later the stock is selling for $39. ​ f. What is your profit or loss from buying the stock? ​ g. What is the option's intrinsic value? ​ h. What is your profit or loss from selling the call? ​ i. If you let the option expire, what do you receive? ​ j. What are the percentage returns you earned on investments in the call and in the stock? ​ k. If the price of the stock had been $30 at the option's expiration, what would have been the percentage returns on investments in the call and in the stock? ​ l. What is the primary reason for purchasing a call instead of the underlying stock?

The strike price of an option is fixed when the option is issued.

Since options offer potential leverage, they tend to sell for a time premium.

The writer of a covered call cannot lose money if the price of the stock rises.

The value of a put is inversely related to the value of the underlying stock.

A writer of a call option closes the position by

A warrant is an option issued by a corporation to buy its stock at a specified price within a specified time period.

A portfolio manager with a position in many stocks may hedge the portfolio by purchasing a stock index call option.

Arbitrage is the act of simultaneously buying and selling in two markets to take advantage of price differentials.

The intrinsic value of a put establishes the put's maximum price.

Which of the following is premised on lower stock prices?