Deck 6: Basic Option Strategies

Question 1

What is the maximum profit that the writer of a call can make?

A) $2,711
B) $289
C) $3,000
D) $3,289
E) none of the above

Answer 1

B

Question 2

Which of the following statements is true about closing a long call position prior to expiration relative to holding it to expiration?

A) the profit is greater at all stock prices
B) the profit is greater only at low stock prices
C) the profit is greater only at high stock prices
D) the range of possible profits is greater
E) none of the above are true

Answer 2

A

Question 3

Which of the following statements is true about the purchase of a protective put at a higher exercise price relative to a lower exercise price?

A) the breakeven is lower
B) the maximum loss is greater
C) the insurance is less costly
D) the insurance is more costly
E) none of the above

Answer 3

D

Question 4

What is your profit if you buy a call, hold it to expiration and the stock price at expiration is $37?

A) $700
B) -$289
C) $2,711
D) $411
E) none of the above

Question 5

What is the disadvantage of a strategy of rolling over a covered call to avoid exercise?

A) the call premium is essentially thrown away
B) transaction costs tend to be high
C) the stock will incur losses
D) the call is more expensive when rolled over
E) none of the above

Question 6

Suppose the buyer of the call in problem 1 sold the call two months before expiration when the stock price was $33. How much profit would the buyer make?

A) $32.89
B) $30.11
C) $78.00
D) $11.00
E) none of the above

Question 7

What is the breakeven stock price at expiration on the transaction described in problem 1?

A) $32.89
B) $30.00
C) $27.11
D) $32.15
E) there is no breakeven

Question 8

What is the maximum profit from the transaction described in Question 6 if the position is held to expiration?

A) $3,289
B) $289
C) infinity
D) $2,711
E) none of the above

Question 9

What is the minimum profit from the transaction described in Question 6 if the position is held to expiration?

A) -$2,711
B) -$3,289
C) -$3,000
D) negative infinity
E) none of the above

Question 10

Which of the following strategies has essentially the same profit diagram as a covered call?

A) a long put
B) a short put
C) a protective put
D) a long call
E) none of the above

Question 11

Which of the following is equivalent to a synthetic call?

A) a long stock and a short put position
B) a long put and a long stock position
C) a long put and a short risk-free bond position
D) a long stock and a short risk-free bond position
E) none of the above

Question 12

If the transaction described in problem 6 is closed out when the option has three months to go and the stock price is at $36, what is the investor's profit?

A) $600
B) $311
C) $889
D) $229
E) none of the above

Question 13

Suppose the investor constructed a covered call. At expiration the stock price is $27. What is the investor's profit?

A) $589
B) $289
C) $2,989
D) $2,711
E) none of the above

Question 14

What is the maximum profit on the transaction described in problem 1?

A) $2,711
B) infinity
C) zero
D) $3,289
E) $3,000

Question 15

Each of the following is a bullish strategy except

A) a long call
B) a short put
C) a short stock
D) a protective put
E) none of the above

Question 16

Which of the following transactions does not profit in a strong bull market.

A) a short put
B) a covered call
C) a protective put
D) a synthetic call
E) none of the above

Question 17

Consider two put options differing only by exercise price. The one with the higher exercise price has

A) the lower breakeven and lower profit potential
B) the lower breakeven and greater profit potential
C) the higher breakeven and greater profit potential
D) the higher breakeven and lower profit potential
E) the greater premium and lower profit potential

Question 18

Early exercise imposes a risk to all but one of the following transactions.

A) a short call
B) a short put
C) a protective put
D) an uncovered call
E) none of the above

Question 19

Which of the following strategies has the greatest potential loss?

A) an uncovered call
B) a long put
C) a covered call
D) a long position in the stock
E) it is impossible to tell

Question 20

What is the breakeven stock price at expiration for the transaction described in problem 6?

A) $27.11
B) $30.00
C) $32.89 d $29.89
E) none of the above

Question 21

An investor can construct a synthetic put by buying a call and selling short a stock.

Question 22

The difference in profit from an actual put and a synthetic put is

A) X
B) S_T - X
C) X - S_T
D) S_T + X(1 + r)^-T
E) none of the above

Question 23

Which of the following statements about a covered call writing strategy is true?

A) the losses are limited
B) return and risk are greater than that of simply holding the stock
C) it is a cheaper form of insurance than a protective put
D) it generally makes a large number of small profits
E) none of the above

Question 24

A protective put can be profitable during a bull market, while a covered call is profitable only in a bear market.

Question 25

To maximize profits on a call purchase, one should hold the position for as short a time as possible.

Question 26

The holder of a protective put has the equivalent of an insurance policy on the stock.

Question 27

A covered call writer who prefers even less risk should

A) get rid of the call
B) switch to a call with a lower exercise price
C) get rid of the stock
D) switch to a call with a higher exercise price
E) none of the above

Question 28

A synthetic long call position can be created with which of the following sets of transactions.

A) borrow the present value of the strike price, sell stock, sell put
B) lend the present value of the strike price, sell stock, buy put
C) sell put, buy stock, lend the present value of the strike price
D) buy stock, buy put, borrow the present value of the strike price
E) none of the above creates a synthetic long call position

Question 29

Which of the following is the breakeven for a protective put?

A) X + S₀ - P
B) P + S₀
C) X - S_T
D) X - S₀ - P
E) none of the above

Question 30

A synthetic short put position can be created with which of the following sets of transactions.

A) borrow the present value of the strike price, sell stock, sell call
B) lend the present value of the strike price, sell stock, buy call
C) sell call, buy stock, lend the present value of the strike price
D) buy stock, buy call, borrow the present value of the strike price
E) none of the above creates a synthetic long call position

Question 31

An advantage of using a put over a short sale is that the short sale requires an uptick or zero-plus tick while a put does not.

Question 32

Because of the greater time value, a call writer who closes the position prior to expiration will always pay more for the call than if the position were held to expiration.

Question 33

The maximum loss on a call purchase is the premium on the call.

Question 34

Consider the following statement related to writing a naked call option. For a given stock price, the ____________ the position is held, the more time value it loses and the ___________ the profit. Identify the correct words for these two blanks.

A) longer, lower
B) longer, higher
C) shorter, lower
D) shorter, higher
E) longer, flatter

Question 35

Buying a put is the mirror image of buying a call.

Question 36

A covered call writer will make a lower profit if the option is exercised early.

Question 37

Identify the correct statement related to the choice of exercise price for buying a call.

A) the higher the exercise price the higher the call premium
B) the lower the exercise price the more likely the call option will expire out-of-the-money
C) A higher strike price results in smaller gains on the upside but smaller losses on the downside
D) the higher the exercise price the more dividends contribute to the overall profit
E) none of the above are correct statements related to the choice of exercise price for buying a call

Question 38

Consider the following statement related to buying a put option. For a given stock price, the ____________ the position is held, the more time value it loses and the ___________ the profit; however, an exception can occur when the stock price is ___________. Identify the correct words for these two blanks.

A) longer, lower, low
B) longer, higher, high
C) shorter, lower, low
D) shorter, higher, high
E) longer, flatter, low

Question 39

Buying a call with a lower exercise price offers a greater profit potential than one with a higher exercise price.

Question 40

Which of the following investors may be obligated to buy stock?

A) covered call writer
B) call buyer
C) put writer
D) protective put buyer
E) none of the above

Question 41

As long as puts are available for trading, there is little justification for constructing synthetic puts.

Question 42

A covered call with a higher exercise price has a higher breakeven.

Question 43

Both call and put writers have the potential for unlimited losses.

Question 44

To reach breakeven on a call purchase held to expiration, the stock price must exceed the exercise price by at least the amount of the call premium.

Question 45

The break-even stock price equation is similar for both calls and puts, the strike price plus the option premium.

Question 46

Given two bearish investors, the more risk averse investor would tend to select a put with a higher exercise price.

Question 47

The breakeven for a protective put is the same as that for a covered call.

Question 48

The profit for a long put is higher for a given stock price if the put is sold back prior to expiration.

Question 49

A covered call provides protection for a stock price at expiration down to the current stock price minus the premium.

Question 50

The profit from a covered call is the profit from a long stock plus the profit from a long call.

Question 51

The following is the profit equation for a put option: Π = N_P[Max(0, X - S_T) + P].

Question 52

If S_T > X, then the profit for a call option can be expressed as: Π = S_T - X - C.

Question 53

A synthetic put is always less expensive than a synthetic call.

Question 54

In the context of insurance, protective put buyers who choose lower exercise prices are essentially using higher deductibles.

Question 55

Covered call writing should be considered a strategy to enhance the return on a stock.

Question 56

Covered calls are a less costly way to protect stocks because you receive money for the sale of the call, whereas you must pay money for a protective put.

Question 57

Any strategy consisting of only long options will lose money if the stock price stays the same.

Question 58

Selling a put is a bullish strategy that has a limited gain (the premium) and a large, but limited, potential loss.

Question 59

A long put option position can be synthetically created by purchasing a call option, short selling the stock, and purchasing a pure discount bond with face value equal to the strike price.

Question 60

A protective put provides the same type of profit diagram as a long call.