Deck 11: Options

Question 1

To hedge a portfolio of BHP shares, we would:

A) buy a call option.
B) write a call option.
C) buy a put option.
D) write a put option.

Answer 1

C

Question 2

Creating a synthetic put is represented algebraically as:

A) C = S - P.
B) P = - S - C.
C) S = C + P.
D) P = C - S.

Answer 2

D

Question 3

Viewed from left to right, the payoff diagram for a call option holder:

A) starts below zero with an upward sloping section before flattening out above zero.
B) starts with a flat section above zero and then falls away to the right.
C) starts with a downward sloping section above zero and then flattens out below zero.
D) starts with a flat section below zero and then becomes an upward sloping line to the right.

Answer 3

D

Question 4

Which of the following statements is TRUE?

A) At low market prices there is greater chance that a call option will be exercised.
B) The difference between the current payoff and the expiry payoff is the time value.
C) Time value is at a peak when the option is in- the- money.
D) When market prices are high the buyer of a call option is paying an insignificant amount for intrinsic value.

Question 5

A collar is a combination of:

A) cap and floor.
B) spread and cap.
C) cap and straddle.
D) spread and floor.

Question 6

Which of the following is the correct term for the price of an option?

A) Strike price.
B) Premium.
C) Exercise price.
D) Discount.

Question 7

The diagram for a bought straddle:

A) has a V- shape.
B) is a curve falling from left to right.
C) has an inverted ▲- shape.
D) is a line rising from left to right.

Question 8

A call option writer:

A) is obliged to buy the underlying security if the option is exercised.
B) has a maximum profit equal to the premium plus the strike price.
C) makes a loss to the left of the strike price.
D) none of the above.

Question 9

Investors may find hedging using options unattractive because:

A) the protection is permanent and the investor cannot exit.
B) the face value of their position is unknown.
C) the option premium is taxable.
D) the premium is expensive.

Question 10

A player would use a ratio spread if:

A) the price is expected to rise.
B) he/she expects a large price change.
C) the price is expected to fall.
D) the timing of the underlying security is uncertain.

Question 11

In the Black- Scholes pricing formula, a delta of 0.50 means:

A) a one cent movement in the price of the option will cause a 0.50 loss to the holder's portfolio.
B) a one cent movement in the price of the underlying security will cause a 0.50 change in gamma.
C) a one cent movement in the price of the underlying security will cause a 0.50 cent change in the value of the option.
D) a 0.50 cent movement in the price of the option will halve the time value.

Question 12

Options on shares were first traded on the ASX in the:

A) 1960s.
B) 1980s.
C) 1970s.
D) 1990s.

Question 13

An investor wishing to be protected against falls in interest rates would use a:

A) floor.
B) collar.
C) spread.
D) cap.

Question 14

Business arrangements that give a corporate the rights to an investment project are known as options.

A) real
B) executive
C) share
D) call

Question 15

A strategy involving four option contracts is:

A) a butterfly spread.
B) a put bear spread.
C) a ratio spread.
D) a call bull spread.

Question 16

Theta in the Black- Scholes formula measures:

A) the change in the option value caused by a change in the volatility of the security price.
B) the effect of time to expiry on the option premium.
C) the impact of the interest rate on the option premium.
D) the effect of the security return on the value of the option.

Question 17

A synthetic call option on a share is created by:

A) buying two shares.
B) buying the share and buying a put option on the share.
C) selling the corresponding put option.
D) selling the call option and buying the put option.

Question 18

The graph of the typical time decay pattern of an option is shaped:

A) as a convex curve rising from left to right.
B) as a flat line above zero which then drops away to the right.
C) as a flat line below zero which then begins to rise to the right.
D) as a concave curve falling from left to right.

Question 19

An option strategy that involves buying a put and call with the same strike price is known as a:

A) strangle.
B) collar.
C) straddle.
D) butterfly.

Question 20

Options are available via:

A) the Australian Stock Exchange.
B) the Sydney Futures Exchange.
C) the banks.
D) all of the above.

Question 21

Options:

A) can be used to sell securities but not to buy them.
B) can be used to buy securities but not to sell them.
C) give the holder the obligation to buy or sell a security.
D) give the holder the right but not the obligation to buy or sell a security.

Question 22

A university student holds a put option for a BHP share with strike price $24 and premium $2. If the spot price at expiry date is $20, she will:

A) let the option lapse and make a loss of $2.
B) exercise the option by buying at $24 and then sell at $20 for a net profit of $2 after allowing for the premium.
C) exercise the option by selling at $24 and then buy at $20 for a net profit of $2 after allowing for the premium.
D) buy at $20 in the spot and then buy an option costing $2 for a net profit of $2.

Question 23

Time decay of an option refers to the fall in the time value as it gets closer to expiry.

Question 24

is when the price of a call equals the cost of a physical security holding minus the price of the corresponding put.

A) The intrinsic value
B) Gamma delta equality
C) A butterfly spread
D) Put call parity

Question 25

Portfolio insurance is a technique that:

A) programs trading decisions so they can be automated.
B) constructs a synthetic put option for a share portfolio.
C) makes an arbitrage profit whenever share prices fall.
D) puts in place a ratio spread.

Question 26

Although options provide greater flexibility than futures, they are not always preferred because of:

A) the premium.
B) lack of transparency.
C) the spread.
D) the uncertainty.

Question 27

Which of the following is NOT a factor that influences option prices?

A) The option premium.
B) The time until option expiry.
C) The strike price of the option.
D) The market price of the underlying security.

Question 28

If a transaction becomes unattractive because of price movements or a change in circumstances, options allow the holder to choose not to proceed with the transaction.

Question 29

The profit that would be made if the option were exercised today is known as:

A) time value.
B) time decay.
C) delta.
D) intrinsic value.

Question 30

Buying a put at $13 and selling a call at $14 is an example of a:

A) butterfly.
B) floor.
C) cap.
D) collar.

Question 31

A call bull spread involves:

A) buying a call with a high strike price and selling a put with a low strike price.
B) selling a call with a low strike price and selling a put with a high strike price.
C) buying a call with a low strike price and selling one with a high strike price.
D) none of the above.

Question 32

American options differ from European options in what way?

A) They can only be exercised on the day of expiry.
B) They can be exercised any time up until expiry.
C) They have no expiry date.
D) Their premium is zero.

Question 33

Using a cap, the borrower loses when interest rates fall.

Question 34

Collars are appropriate for hedging when there is a good chance interest rates will fall.

Question 35

Where the underlying instrument is itself a derivative product, such as a futures contract, there will be no cash value paid or received upon expiry of the option.

Question 36

The price at which the underlying security of an option can be bought is called the premium.

Question 37

A simple representation of put- call parity is S = C + P.

Question 38

Compared with fixed- rate derivatives such as futures, an option:

A) is less expensive but less flexible.
B) is more expensive and less flexible.
C) is more expensive but more flexible.
D) is less expensive and more flexible.

Question 39

The writer of a $14 call option on a BHP share has received a premium of 50 cents. If the spot price at expiry time is $16, the writer makes a net loss of $1.50.

Question 40

Collars are attractive to borrowers because they:

A) have low prices.
B) are simple to understand.
C) eliminate uncertainty.
D) all of the above.

Question 41

If the market price rises, losses are made on sold puts, and held calls produce profits.

Question 42

Interest rates are a factor in option pricing because of the effect of the options market on RBA monetary policy considerations.

Question 43

Collars have the drawback of a large up- front fee.

Question 44

Premiums paid by investors for options contracts are not tax deductible in Australia.

Question 45

To hedge a portfolio of BHP shares, we can buy a put option and at the same time take advantage of any upside movement in BHP share prices.

Question 46

The Black- Scholes model of pricing applies to a wide range of options including shares, commodities and FX but does not apply to interest rate options.

Question 47

The more volatile a security's price, the lower is the option premium.

Question 48

The strike price is the rate at which the underlying security can be bought when the option expires, and the exercise price is the rate at which the security can be sold when the option expires.

Question 49

There are four factors that affect option prices and these are captured in the Black- Scholes formula.

Question 50

Options are always exchange- traded.

Question 51

The option premium will decay rapidly at first and then slow down.

Question 52

European options have the advantage that the holder can exercise them at any time until expiry.

Question 53

If we believe share prices will not move a great deal, we can profit by putting in place a straddle.

Question 54

If the market price of a commodity is higher than the call's strike price, we say the option is 'in- the- money'.

Question 55

The approach of using a 'collar' is not appropriate when we believe there is a good chance the share price will decrease.

Question 56

Assume a three- month put option on a BHP share has strike price of $14 and premium of 25 cents. Then the payoff to the holder at a spot price of $21 is minus 25 cents.

Question 57

A call bull spread strategy is appropriate when the user believes the price of the underlying security will rise.

Question 58

If a borrower buys a floor with strike price 10% and premium 0.3%, then he or she is protected if interest rates rise above 10%.

Question 59

Fund managers can use a sold call option to add return to their share portfolio.

Question 60

Call option writing leads to unlimited profit with limited risk, while put option writing leads to limited profit with unlimited risk.

Question 61

When market prices are high, the buyer is paying a significant amount for the intrinsic value of a call option which could be completely lost if prices fall prior to expiry so the option becomes less attractive at higher prices.

Question 62

Options were traded as far back as the 17th century.

Question 63

If a university student wishes to create a synthetic share call option, she would sell the underlying share and buy a put option on the share.

Question 64

An OTC interest rate option which protects an investor against falls in interest rates below a specified level is called a floor.

Question 65

Discuss the factor affecting option prices.

Question 66

Explain the 'two prices' of options.

Question 67

What is portfolio insurance?

Question 68

Despite the different exercising arrangements of American and European options, they usually have prices that are close to each other.

Question 69

With the aid of diagrams and examples, compare and contrast call and put options.

Question 70

Explain the difference between intrinsic value and time value of an option.