Deck 14: Options: Puts and Calls

Question 1

ETF options are settled in

A) the writer has the choice of settling in either cash or ETF shares.
B) ETF shares.
C) share of the companies in the index.
D) cash.

Answer 1

B

Question 2

The purchase of a June 25 call on XXO share and the sale of a June 30 call on XXO share is known as a

A) horizontal spread.
B) long straddle.
C) vertical spread.
D) short straddle.

Answer 2

C

Question 3

The price of ABC shares is currently $42 per share, but in six months you expect it to rise to $50. ABC does not pay a dividend. You buy a six- month call on ABC, with a strike price of $45. The option cost $200. What holding period return do you expect on this call? Ignore transaction costs and taxes.

A) 200%.
B) 150%.
C) 250%.
D) 300%.

Answer 3

B

Question 4

If the Canadian dollar became stronger relative to the Australian dollar, the price of

A) both the call and the put options on the Canadian dollar will decrease.
B) a call option on the Canadian dollar will decrease.
C) a call option on the Canadian dollar will increase.
D) a put option on the Canadian dollar will increase.

Question 5

The most important factor affecting the market price of a put or call is the

A) expiration date.
B) market interest rate.
C) price behaviour of the corresponding warrant.
D) price behaviour of the underlying shares.

Question 6

The value of an interest rate call option

A) is based on the market price of U.S. Treasury securities.
B) increases when the yield on the underlying Treasury security rises.
C) decreases when the price of U.S. Treasuries decreases.
D) varies directly with the price of the underlying corporate bond.

Question 7

ABC shares are currently selling for $128. Which of the following options is "in- the- money"?

A) February 125 call.
B) March 125 put.
C) February 100 put.
D) March 130 call.

Question 8

Fred bought 600 shares of Edgewood shares at a price of $19. The shares are currently selling for $53 a share. To protect his profits, Fred should buy

A) 6 put options with a strike price of $50.
B) 6 call options with a strike price of $55.
C) 600 call options with a strike price of $55.
D) 600 put options with a strike price of $50.

Question 9

Which one of the following actions would be the most appropriate hedge to a short sale of shares?

A) Sale of a call.
B) Purchase of a call.
C) Purchase of a put.
D) Sale of a put.

Question 10

Roselle paid $250 to buy one put option with a strike price of $35. What is the maximum profit Roselle can earn on her option contract?

A) $100.
B) $3,250.
C) $350.
D) Her profit potential is unlimited.

Question 11

Kyle believes the price of Ajax shares is about to decrease. If he wants to profit from the decline in price, he should on Ajax shares.

A) sell a put
B) buy a put
C) write a put
D) buy a call

Question 12

The strike price of a put option is the price

A) of the underlying share at the time that the options contract is purchased.
B) at which the underlying share can be sold.
C) at which the underlying share can be bought.
D) an investor must pay for the options contract.

Question 13

For all practical purposes, listed share options always expire

A) on the last business day of the expiration month.
B) on the Thursday before the last Friday of the expiration month.
C) three months from the date of the option purchase.
D) on the first Monday of every calendar quarter.

Question 14

Grant purchased one call on XYZ shares at an exercise price of $25. The market price of XYZ shares when Grant purchased the call was $24 a share. XYZ is currently priced at $30 a share. Grant paid $120 to buy the call. How much profit will Grant make if he exercises the option today and then sells the shares? Ignore all transaction- related costs.

A) $500.
B) $480.
C) $380.
D) $600.

Question 15

What is the time premium of a put with a strike price of $25 when the option price is $2 and the underlying shares sell for $24?

A) $100.
B) $400.
C) $300.
D) $200.

Question 16

The writer of a put

A) is hoping that the put will be in- the- money prior to expiration.
B) accepts the obligation to sell a predetermined number of shares at a predetermined price.
C) is betting the price of the underlying security will increase in value.
D) will pay the premium whether or not the option is exercised.

Question 17

Purchasers of share options

A) have the right to buy or sell a certain number of underlying shares.
B) own a financial asset with benefits of firm ownership.
C) have the obligation to buy or sell a predetermined amount of shares at the strike price.
D) have a claim on the profits of the firm issuing the underlying securities.

Question 18

Warrants

A) provide substantially less capital appreciation potential than the underlying share.
B) tend to be quite costly.
C) are not traded in the secondary markets because of their low unit costs.
D) have a stipulated price and an expiration date.

Question 19

Steve bought 300 shares at a price of $20 per share. The price then went up to $33 per share so Steve decided to hedge his position by purchasing 3 puts at a cost of $120 each. The puts have an exercise price of 30. One week prior to the expiration of the puts, the price was at $22 per share. If Steve closed out all of his positions at that time, he would have earned a net profit of

A) $200.
B) $240.
C) $3,000.
D) $2,640.

Question 20

In nearly all cases, the purpose of a hedge is to

A) speculate on a downward drop in a general market index.
B) speculate on an upward movement in a given currency.
C) reduce or eliminate risk.
D) make a very high profit in an extremely short time frame.

Question 21

If the ASX 200 index is at 1,061, then the cash value of an ASX 200 index option is

A) $10,610.
B) $10.61.
C) $106,100.
D) $1,061.

Question 22

A long straddle

A) is a strategy that produces profits when the price of the underlying security moves significantly in either direction.
B) is a strategy based on the expectation that the price of the underlying security will be relatively constant.
C) consists of selling and writing an equal number of puts and calls with different strike prices but the same expiration date and the same underlying security.
D) consists of buying a call at one strike price and then writing a call at a higher strike price.

Question 23

An option straddle is the simultaneous purchase (or sale) of both a put and a call option on the same underlying security.

Question 24

Investors who purchase options acquire nothing more than the right to buy or sell the shares of the underlying security.

Question 25

The writer of a covered call has taken a(n)

A) conservative investment position with limited profits.
B) conservative investment position with unlimited potential profits.
C) aggressive position with limited losses and unlimited potential profits.
D) aggressive position with potentially unlimited profits or losses.

Question 26

The ability to obtain a given equity position at a reduced capital investment, and therefore magnify returns, is known as

A) triple witching.
B) leverage.
C) straddling.
D) hedging.

Question 27

Which one of the following statements concerning options is correct?

A) The owner of a call is entitled to the dividends paid on the underlying shares of stock.
B) Option holders can profit on movements of the price of the underlying security.
C) One option covers 2,000 shares.
D) A put gives the option holder the right to buy a stated amount of securities.

Question 28

The premium on a share- index call would be expected to increase as the

A) option life nears expiration.
B) index price falls further below the strike price.
C) underlying securities stabilise in value.
D) market becomes more volatile.

Question 29

Jason purchased a six- month put on ABC shares at a cost of $100. The strike price was $15. At what market price does Jason just break- even on this investment? Ignore transaction costs and taxes.

A) $16.
B) $15.
B) Cannot be determined from the information provided.
C) $14.

Question 30

Listed options

A) are rarely traded in the secondary markets.
B) are traded directly between the buyer and the seller.
C) have readily available price information.
D) are sold over the counter.

Question 31

Lew paid $300 to purchase a call on XYZ with a strike price of $25. What does the market price of XYZ have to be for Lew to break- even on his option investment? Ignore transaction costs and taxes.

A) $22.
B) $28.
B) Cannot be determined from the information provided.
C) $25.

Question 32

One reason that writing options can be a viable and profitable investment strategy is that

A) an option writer can exercise the option to avoid a potential loss.
B) most options expire unexercised.
C) an option writer determines when the option is exercised.
D) the option writer collects the quarterly dividends.

Question 33

For a call purchased on an organised security exchange, the strike price specifies the

A) cost of buying one option contract based on the value of the underlying share.
B) intrinsic value of the offsetting put.
C) prevailing market price of one share.
D) contractual price at which each of the shares can be bought.

Question 34

A put has fundamental value as long as

A) the market price of the underlying financial asset is less than the strike price.
B) the strike price of the put is greater than the time premium of the put.
C) the market price of the underlying financial asset has a positive value.
D) the strike price of the put is less than the market value of the underlying asset.

Question 35

The two provisions which investors should carefully consider when evaluating share options are the

A) premium and the discount.
B) leverage ratio and the time to maturity.
C) time until expiration and the strike price.
D) strike price and the exchange ratio.

Question 36

Which of the following is true about rights?

A) The owner has several years in which to exercise the option.
B) They are a type of short- lived call option.
C) They are a type of short- lived put option.
D) They are usually attached to bonds as a "sweetener"

Question 37

Matt owns 500 shares of IKM stock. The market price of IKM is $51.74. Matt just sold five calls on IKM with a strike price of $50. This is known as

A) covering a short position.
B) writing a naked call.
C) writing a covered call.
D) creating a naked cover.

Question 38

One could temporarily protect profits on a highly diversified portfolio of large company shares by
A) buying ASX 200 Index put options.

A) selling ASX 200 Index call options.
B) buying ASX 200 Index call options.
D) selling ASX 200 Index put options.

Question 39

The maker of a put or call is the

A) party who decides whether or not the option is exercised.
B) party who writes the option.
C) person who facilitates the trade on the floor of the exchange.
D) company which issued the underlying security.

Question 40

Which one of the following was the first listed exchange for stock options in the United States?
A) Chicago Board Options Exchange.

A) Stock Index Board.
B) Philadelphia Board of Trade.
D) New York Stock Exchange.

Question 41

Writing covered calls may result in a profit to the writer even if the share price does not change.

Question 42

If you expect the price of a security to decline, you could buy a call to protect your financial position.

Question 43

The buyer of a put expects the price of the underlying security to rise.

Question 44

The maximum loss that can be incurred as the buyer of an option is the amount of the option premium.

Question 45

Once the call premium is recouped, the profit from a call is only limited by the price increases of the underlying share prior to the contract expiration.

Question 46

European options can only be sold on the expiration date.

Question 47

To exercise a call option on the ASX 200, an investor would need to actually buy all stocks at the strike price.

Question 48

Warrants are short- term options usually expiring within a year or less.

Question 49

The party that accepts the legal obligation to stand behind the option is the buyer of the contract.

Question 50

A naked option is a conservative investment with limited risk.

Question 51

The value of a call increases as the price of the underlying security rises.

Question 52

A put option has a strike price of $32. The current price of the share is $34. The put option is said to be "in- the- money."

Question 53

Listed options trade over- the- counter.

Question 54

Covered call writers have unlimited loss exposure as well as unlimited profit potential.

Question 55

Standardised options expire on the last business day of the expiration month.

Question 56

The writer of a call option is theoretically exposed to an unlimited loss.

Question 57

The maximum amount the buyer of a put can lose is the cost of the option.

Question 58

The longer the time to expiration, the lower the option time premium tends to be.

Question 59

American style options can only be exercised on their expiration dates.

Question 60

Puts and calls are issued by the same corporation that issued the underlying share.

Question 61

Which one of the following options is more expensive? Show all calculations.
a() A six- month put that carries a $40 strike price on a share that is currently trading at $35.84, given that the put trades at a 15 percent investment premium; or
b() A six- month call that carries a $50 strike price on a share that currently trades at $54.75, while the call trades with a 12 percent investment premium?

Question 62

Alan just bought 100 shares of Global, Inc. (GLO) at $45 per share and as protection he also bought a
three- month put with a $45 strike price at a cost of $400. One of two scenarios is expected to occur in the next three months: (a) GLO shares decline to $33; and (b) GLO shares rise to $61. Calculate the profit or loss under each scenario and explain how the hedge has provided protection for Alan's position in GLO. Ignore transaction costs.

Question 63

Over- the- counter options are less structured than listed options and are primarily purchased by individual investors.

Question 64

What is the difference between a naked call option and a covered call option? Which one is riskier and why?

Question 65

Many options expire without being exercised.

Question 66

Because puts and calls derive their value from the behaviour of some other real or financial asset, they are known as derivative securities.

Question 67

Amy owns 100 shares of ABC stock with a cost basis of $35 a share. The stock is currently trading at $54 a share. Amy believes the price of ABC stock will fall to $45 a share in the near future but over the longer term of 3 to 5 years, increase in value to $75 a share. Amy would like to benefit from the expected near- term decline if it occurs. Therefore, Amy writes a covered call at a strike price of $55 and a premium of $2.
a() How will the covered call help Amy profit if the expected price decline occurs?
b() What is the maximum loss Amy can incur from the call?
c() What is the maximum profit Amy can incur from the call?

Question 68

Rights are long- term call options attached to bonds while warrants are short- term call options attached to shares.

Question 69

Rights are call options issued to current owners of the shares and normally expire within a short period of time.

Question 70

Writing covered calls protects the writer from losses if the price of the underlying share declines.

Question 71

If a share price does not rise or fall by the amount of the option premium, the option will not be exercised.

Question 72

While share- index options can be used to play the market as a whole, they are also effective in protecting equity portfolios against falling markets.

Question 73

For the writer of in- the- money covered calls, losses on the options contract will be nullified by gains on the shares.

Question 74

Explain how an investor can use a share- index option to hedge a portfolio of common shares.