Deck 27: Options Markets

Question 1

The profit and loss profile of the short call position (that is, the position of the call option writer) is the ________ the profit and loss profile of the long call position (the position of the call option buyer).

A) same as
B) the identical image of
C) mirror image of
D) All of these

Answer 1

C

Question 2

Which of the below statements is TRUE?

A) In the case of a futures contract, the buyer of the contract realizes a dollar-for-dollar loss when the price of the futures contract increases.
B) The maximum profit that the writer (seller) of an option may realize is the option price; this is offset against substantial downside risk.
C) In the case of a futures contract, the buyer of the contract suffers a dollar-for-dollar loss when the price of the futures contract rises.
D) The risk/reward characteristics of a futures contract and an option contract are identical.

Answer 2

B

Question 3

Suppose you purchase a call option on Asset XYZ that has an exercise price of $100. The option price is $3 per share. Suppose that on the expiration date, you exercise your option at the current price of $106. What is your net profit or loss per share?

A) -$3.00
B) $0.00
C) $3.00
D) $6.00

Answer 3

C

Question 4

When the option buyer has the right to sell the underlying to the writer, the option is called a ________.

A) call option.
B) put obligation.
C) exercise option.
D) put option.

Question 5

Which of the below statements is TRUE?

A) Illustrations of the four option positions take into account the time value of money.
B) The breakeven price for the underlying asset at the expiration date is lower for the buyer of the option; for the seller, it is higher.
C) The buyer of a call option is not entitled to any interim cash flows generated by the underlying asset.
D) All of these

Question 6

Suppose you purchase a put option on Asset XYZ that has an exercise price of $40. The option price is $2 per share. Suppose that on the expiration date, the current price is $39. What is your net profit or loss?

A) -$3.00
B) -$1.00
C) $0.00
D) $1.00

Question 7

In an option contract, the writer of the option grants the buyer of the option the ________, but not the ________, to purchase from or sell to the writer something at a specified price within a specified period of time (or at a specified date).

A) obligation; right
B) obligation; privilege
C) right; obligation
D) right; privilege

Question 8

One distinction between futures and options contracts is that ________ to an option contract ________ to transact at a later date.

A) one party; is not obligated
B) both parties; are not obligated
C) one party; is obligated
D) both parties; are obligated

Question 9

The date after which an option is void is called the ________.

A) termination date.
B) maturity date.
C) cessation date.
D) expiration period.

Question 10

The price at which the underlying (that is, the asset or commodity) may be bought or sold is called the ________.

A) exercise price.
B) wallop price.
C) strike-out price.
D) strike charge.

Question 11

The maximum amount that an option buyer can lose is the ________ price. The maximum profit that the option writer (seller) can realize is the ________ price.

A) option; exercise
B) call; option
C) option; option
D) call; put

Question 12

In regards to the writing (selling) of put options, which of the below statements is TRUE?

A) The profit and loss profile for a short put option is the mirror image of the long put option.
B) The theoretical maximum loss can be substantial should the price of the underlying asset fall; at the outside, if the price were to fall all the way to zero, the loss would be as large as the strike price less the option price.
C) The profit and loss profile for a short put option is the mirror image of the long put option with the maximum profit from this position being the option price
D) All of these

Question 13

Futures contracts allow ________.

A) investors to hedge the risks associated with favorable and known price movements.
B) market participants to lock in a price and thereby take on price risk.
C) investors to acquire the opportunity to benefit from a favorable price movement.
D) market participants to trade off the benefits of a favorable price movement for protection against an adverse price movement.

Question 14

Suppose you purchase a call option on Asset XYZ that has an exercise price of $50. The option price is $3 per share. Suppose that on the expiration date, the current price is $49. What is your net profit or loss per share?

A) -$4.00
B) -$3.00
C) -$2.00
D) $0.00

Question 15

There are four basic option positions. Which of the below is ONE of these four positions?

A) Buying a call option (short a call option)
B) Selling a call option (long a call option)
C) Buying a put option (short a put option)
D) Selling a put option (short a put option)

Question 16

Suppose you purchase a put option on Asset XYZ that has an exercise price of $100. The option price is $3 per share. Suppose that on the expiration date, you exercise your option at the current price of $96. What is your net profit or loss per share?

A) -$3.00
B) -$1.00
C) $0.00
D) $1.00

Question 17

Suppose you purchase a call option on Asset XYZ that has an exercise price of $50. The option price is $2 per share. Suppose that on the expiration date, the current price is $50. What is your net profit or loss per share?

A) -$2.00
B) $0.00
C) $1.00
D) $2.00

Question 18

There are options that may be exercised at any time up to and including the expiration date. Such options are referred to as ________ options. Other options may be exercised only at the expiration date; these are called ________ options.

A) European; American
B) American; Asian
C) Asian; European
D) American; European

Question 19

In the case of a ________, both buyer and seller are obligated to perform.

A) call option contract
B) put option contract
C) futures contract
D) All of these

Question 20

Which of the below statements is FALSE?

A) An option is a contract in which the writer of the option grants the buyer the right, but not the obligation, to purchase from or sell to the writer something at the exercise (or strike) price within a specified period of time (until the expiration date).
B) The price paid by the option buyer is called the option price or option premium.
C) A call option grants the option buyer the right to buy something from the option writer, and a put option grants the option buyer the right to sell something to the option writer.
D) None of these

Question 21

In regards to FLEX options, which of the below statements is TRUE?

A) A FLEX option is an option contract with some terms that have been customized and is traded on an options exchange and cleared and guaranteed by the associated clearinghouse for the exchange.
B) A FLEX option cannot be created for individual stocks, stock indexes, and Treasury securities.
C) The development of the FLEX option is a response to the declining over-the-counter market.
D) The FLEX option represents a disconnection between listed options and OTC products.

Question 22

Which of the below statements is TRUE?

A) A put option can be used to protect against a rise in the price of the underlying instrument while maintaining the opportunity to benefit from a decline in the price of the underlying instrument.
B) Hedging with options never differ from hedging with futures.
C) Hedging with futures involves trading off the benefits of a favorable price movement for protection against an adverse price movement.
D) None of these

Question 23

An American option, also referred to as an Atlantic option, can be exercised only on specified dates.

Question 24

Which of the below statements is FALSE?

A) All exchange-traded stock options in the United States may be exercised any time before the expiration date; that is, they are European options.
B) Options are designated by the name of the underlying common stock, the expiration month, the strike price, and the type of option (put or call).
C) The practice is to trade options with an expiration date of the current calendar month, the next calendar month, and the next two expiration months in the cycle.
D) As with stock index futures, all stock index options have a multiple and the multiple is $100 for the four popular stock index options.

Question 25

Which of the below statements is FALSE?

A) Complex OTC options are called exotic options.
B) An alternative option, also called an either-or option, has a payoff which is the best independent payoff of two distinct assets.
C) An outperformance option is an option whose payoff is based on the relative payoff of two assets at the expiration date.
D) None of these

Question 26

What is the dollar value of the S&P 100 contract if the multiple for the S&P 100 Stock Index is $100 and the cash index value for the S&P 100 is 620?

A) $60,000
B) $62,000
C) $64,000
D) None of these

Question 27

Suppose that a futures contract with Asset XYZ as the underlying instrument has a futures price equal to $100 and a settlement date one month from now. Which of the below statement is FALSE for an investor who SELLS this futures contract?

A) By selling this futures contract, the investor would be agreeing to sell Asset XYZ for $100 one month from now.
B) If Asset XYZ's price falls below $100, the investor (who sells this futures contract) is protected because she will receive $100 upon delivery of the asset to satisfy the futures contract.
C) If Asset XYZ's price rises above $100, the investor (who sells this futures contract) will not realize the price appreciation because she must deliver the asset for an agreed-upon amount of $100.
D) By selling the futures contract, the investor has locked in a price of $100, and fails to realize a gain if the price declines while avoiding a loss if the price rises.

Question 28

In regards to interest rate options, which of the below statements is TRUE?

A) Interest rate options cannot be written on cash instruments or futures.
B) At one time, there were several exchange-traded option contracts whose underlying instrument was a debt instrument. These contracts are referred to as futures on physicals.
C) In recent years, market participants have made decreasingly greater use of over-the-counter options on Treasury, agency debentures, and mortgage-backed securities.
D) Besides options on fixed-income securities, investors can obtain OTC options on a yield spread.

Question 29

The maximum amount that an option buyer can lose is the option price, while the maximum profit that the option writer can realize is the option price; the option buyer has substantial upside return potential, while the option writer has substantial downside risk.

Question 30

There are three reasons why futures options on fixed-income securities have largely supplanted options on physicals as the options vehicle used by institutional investors. Which of the below is NOT one of these three reasons?

A) Unlike options on fixed-income securities, futures options on Treasury coupon futures do not require payments for accrued interest to be made.
B) Futures options are believed to be "cleaner" instruments because of the reduced likelihood of delivery squeezes.
C) In order to price any option, it is imperative to know at all times the price of the underlying instrument.
D) None of these

Question 31

Which of the below statements is FALSE?

A) The S&P 500 Index Option contract is European and the underlying is the S&P 500.
B) There are stock index options for components of the major broad-based stock market indexes, selected industries, and selected sectors.
C) There are stock index options based on the exercise style but not based on the length of the expiration period.
D) Stock index options are cash settlement contracts, which means that, if the option is exercised, the exchange-assigned option writer pays cash to the option buyer.

Question 32

________ can be used to ________ against a decline in the price of the ________ instrument.

A) A call option; hedge; underlying
B) A put option; hedge; underlying
C) A call option; speculate; primary
D) A put option; speculate; secondary

Question 33

In regards to stock index options, which of the below statements is TRUE?

A) There are not options on stock index futures.
B) Options on stock index futures are more widely used than options on stock indexes.
C) Options on futures contracts are the contracts of choice in the interest rate options market.
D) None of these

Question 34

Which of the below statements is FALSE?

A) Options on individual shares of common stock have been traded for many years.
B) Trading of standardized call options on common stock began on the Chicago Board Options Exchange (CBOE).
C) The SEC approved the creation of a national clearing system for options, the Options Clearing Corporation (OCC), jointly established by the CBOE and the American Stock Exchange.
D) Exchange-traded stock options have a nonstandardized quantity.

Question 35

In regards to the mechanics of trading futures options, which of the below statements is FALSE?

A) The exchange imposes margin requirements for the buyer of a futures option once the option price has been paid in full.
B) Because the maximum amount the buyer can lose is the option price, regardless of how adverse the price movement of the underlying instrument, there is no need for margin.
C) Because the writer of an option has agreed to accept all of the risk of the position in the underlying instrument, the writer is required to deposit not only the margin required on the interest rate futures contract position if that is the underlying instrument, but, with certain exceptions, also the option price that is received for writing the option.
D) If prices for the underlying futures contract adversely affect the writer's position, the writer would be required to deposit variation margin as it is marked to market.

Question 36

In regards to long-term equity anticipation securities (LEAPS), which of the below statements is TRUE?

A) LEAPS are option contracts designed to offer option contracts with shorter maturities.
B) LEAPS contracts are available on individual stocks and some indexes.
C) Stock option LEAPS are comparable to standard stock options because the maturities can range up to 39 months from the origination date.
D) Index options LEAPS are the same in size compared with standard index options having a multiplier of 100.

Question 37

An option on a futures contract, commonly referred to as a futures option, gives the buyer the right to buy from or sell to the writer a designated futures contract ________.

A) at an uncertain price on the expiration date.
B) at a random price at any time during the life of the option.
C) at a designated price at a specified time during the life of the option.
D) at a designated price at any time during the life of the option.

Question 38

In regards to the mechanics of trading futures options, which of the below statements is FALSE?

A) Upon exercise, the futures price for the futures contract will be set equal to the exercise price and the position of the two parties is then immediately marked to market based on the then-current futures price.
B) Upon exercise, the option writer or seller must pay the option buyer the economic benefit from exercising.
C) In the case of a call futures option, the option writer must pay the difference between the current futures price and the exercise price to the buyer of the option.
D) In the case of a put futures option, the option buyer must pay the option writer or seller the difference between the exercise price and the current futures price.

Question 39

________ grants the buyer the right to sell one designated futures contract to the writer at the exercise price. That is, the option buyer has the right to acquire a short position in the designated futures contract.

A) A put option on a futures contract
B) A call option on a futures contract
C) A put option on an option contract
D) A call option on an option contract

Question 40

The Options Clearing Corporation has established standard strike price guidelines for listed options. For stocks ________.

A) with a price above $100, option strike prices are set at $10 intervals.
B) with a price below $100 and above $30, strike prices are set at $4 intervals.
C) priced between $10 and $30 the interval is $2.
D) with stock splits, the strike price is not adjusted.

Question 41

There are four basic option positions: buying a call option, selling a call option, buying a put option, and selling a put option.

Question 42

Differentiate between a call option and a put option.

Question 43

Options may be traded either on an organized exchange or in the over-the-counter market.

Question 44

Exchange-traded options on futures that are based on debt instruments have been far less popular than exchange-traded options on physicals.

Question 45

There has been decreased use by institutional investors of over-the-counter options on Treasury and mortgage-backed securities.

Question 46

In determining the payoff from an option, the time value of money as a result of having to finance the option price must be considered.

Question 47

There are interest rate options in which the underlying is a debt instrument (called an option on a physical) and a futures contract (called a futures option).

Question 48

If the buyer of the futures option exercises, the futures price for the futures contract will be set equal to the exercise price, but the position of the two parties is then immediately marked to market based on the then-current futures price.

Question 49

Simple OTC options are called exotic options.

Question 50

Options have a symmetric risk/reward relationship, while futures do not because the buyer of an option retains all the potential benefits, but the gain is always reduced by the amount of the option price.

Question 51

There are options traded on individual shares of common stock and options traded on common stock indexes.

Question 52

An option cannot be used to alter the risk/reward relationship from that of a position in the underlying.

Question 53

A call option gives the buyer the right to buy from or sell to the writer a designated futures contract at a designated price at any time during the life of the option.

Question 54

Like a futures contract, only one party to an option contract is obligated to transact at a later date: the option writer.

Question 55

The buyer of a call option benefits if the price of the underlying is unchanged or falls.

Question 56

Hedging with options allows the option buyer to limit risk but not maintain the potential to benefit from a favorable price movement.

Question 57

Comment on the differences between futures and options contracts.

Question 58

Options allow the investor to mold a risk/return relationship.

Question 59

The dollar value of a stock index option contract is equal to the index value divided by the contract's multiple.

Question 60

The buyer of a put option benefits if the price of the underlying is unchanged or rises.

Question 61

There are three reasons why futures options on fixed-income securities have largely supplanted options on physicals as the options vehicle used by institutional investors. Describe two of these three reasons.

Question 62

Describe an outperformance option and illustrate with an example.

Question 63

Do call options allow investors to protect or hedge against a rise in the price of the underlying instrument? Explain using an illustration to show the hedge outcome.

Question 64

Describe and summarize the meaning of the four option positions.

Question 65

Do futures contracts allow investors to hedge the risks associated with adverse price movements? Explain.