Exam 17: An Introduction to Options

The price of a call depends on 1. the strike price 2. the price of the underlying stock 3. the term (i.e., life)of the call

The value of a put rises as the price of

In addition to put and call options on individual stocks, there are also options on the market as a whole (i.e., an index).

Answer the questions given the following information:      Price of a stock                                 $52      Strike price of a three-month call      $50      Market price of the call                      $4 ​ a. Is the call "out" of the money? ​ b. What is the time premium paid for the call? ​ c. What is the maximum possible loss from buying the call? ​ d. What is the maximum profit the buyer of the call can earn? ​ e. What is the maximum profit the seller of the call can earn? ​ f. What price of the stock will assure that the buyer of the call will not sustain a loss? ​ g. If an investor sells the call covered, what is the cash inflow or cash outflow? After three months (i.e., at the expiration of the options), the price of the stock is $53. ​ h. What is the profit or loss from buying the call? ​ i. What is the profit or loss from selling the call naked? ​ j. At expiration, what is the time premium paid for the call?

Holders of calls do not receive the cash dividends paid to the company's stockholders.

An option's intrinsic value exceeds the option's price.

Because of the small cash outlay to buy an option, these securities are considered to be conservative investments.

Stock index options 1. permit the investor to short the market instead of individual stocks 2. require delivery of an index of stocks 3. limit the buyer's potential loss to the cost of the option

Options sell for a time premium over their intrinsic value because

If an investor anticipates that interest rates will increase, that individual should sell an option to buy Treasury bonds.

The most the investor who sells a naked stock index option can lose is the cost of the option.

Given the following information,       Price of a stock                  $50       Strike price of a six-month call  $45       Market price of the call           $9 Finish the following sentences: a. The intrinsic value of the call is _________. b. The time premium paid for the call is ________. c. If an investor established a covered call position, the amount invested is _________. d. The most the buyer of the call can lose is ________. e. The maximum amount the seller of the call naked can lose is ________. f. Which call is "in" or "out" of the money? After six months (i.e., at the expiration date of the call), the price of the stock is $52. g. The profit (loss)from buying the call is ________. h. The price (loss)from selling the call naked is _______. i. The profit (loss)from selling the call covered is     __________. j. The profit (loss)from selling the stock short six months earlier is _________. k. At expiration, the time premium paid for a put or a call is _________.

If the investor buys a stock index put, the individual will profit if the market rises.

One reason for writing and selling a covered call option is

The writer of a naked call option wants

The time premium paid for an option reduces the option's potential leverage.

If the price of an option to buy stock were to sell for less than its strike price, an opportunity for arbitrage exists.

Because of arbitrage, the price of an option

When a call option is exercised, new stock is issued.

The intrinsic value of an option to buy stock is