AAEC 4317 Final Exam Practice Questions

Suppose that a trader bought a Put option on the stock of Walt Disney Inc. (DIS) with SP = $100/share and paid a Call premium of $4 per share. Right now the stock is selling at $101/share. The intrinsic value of the Call option is equal to

$0/share IV for Put Option (even though it says call, I think it means put): SP-MP IV= 100-101 IV= -$1 Intrinsic Value can not be negative, so stops at $0

Suppose that a trader bought a Call option on Corn Futures contract. The strike price, SP = 350 ¢/bu. and the Call premium paid, C = 20 ¢/bu. The size of Corn Futures contract is 5,000 bu. The amount of total premium this Call holder paid is equal to

$1,000 20 cents*5,000 bu= 100,000 cents 100,000 cents / 100= $1,000

Suppose that a Call option on a stock with strike price $50 per share is trading at $3 (Call premium) per share. The current market price of the stock is $52 per share. The intrinsic value of the Call option is

$2 per share IV for Call Option: MP-SP IV= 52-50 = $2

Suppose that a trader bought a Call option on the stock of Walt Disney Inc. (DIS) with SP = $100/share and paid a Call premium of $2 per share. Right now the stock is selling at $99/share. The time value of the Call option is equal to

$2/share Time Value for Call= Premium -IV IV: MP-SP= 99-100 = -$1 Premium= $2 Tv= 2 I HONESTLY DONT KNOW WHY $2 :(

Suppose that a trader bought a call option on a stock at strike price $25.00 and premium $2.50 per share. Each stock option consists of 100 shares of the stock. The call buyer' total investment in the call option was

$250.00 $2.50 * 100 shares = $250.00

Suppose that a trader bought a Put option on the stock of Walt Disney Inc. (DIS) with SP = $100/share and paid a Put premium of $8 per share. On the expiration date, the stock was selling at $95/share. If the Put holder exercised, the Put writer's profit/loss per share would be

$3/share Put writer Profit/Loss: Put Premium - (SP-MP) =8-(100-95) =8-5 =$3

The net realized price refers to the resulting price of the commodity that the hedger realizes after short hedging, which is equal to:

(Cash Revenue + Total gain/loss from hedging)/(Quantity of the commodity sold)

The net price paid refers to the net cost per unit of the input that the hedger pays after long hedging, which is equal to:

(Total payment in the cash market - Total gain/loss from hedging)/(The quantity of the input purchased)

Suppose that a trader bought a Put option on a Crude Oil Futures contract. The strike price, SP = $45/barrel. and the Put premium paid, P = $5/barrel. The size of Crude Oil Futures contract is 1,000 barrels. One day, the market price of the Crude Oil Futures contract appears to be FP= $42/barrel. If the Put holder decides to exercise the option, her net profit/loss would be:

-$2,000 Put Holder Exercise: Step 1: IV= SP-FP = 45-42 = $3 Step 2: IV-Premium paid= 3-5 = -$2 Step 3: -$2 * 1,000 barrels= -$2,000

Suppose that a trader bought a Call option on Corn Futures contract. The strike price, SP = 350 ¢/bu. and the Call premium paid, C = 20 ¢/bu. The size of Corn Futures contract is 5,000 bu. One day, the market price of the Corn Futures contract appears to be FP= 375 ¢/bu. The Call holder exercises the option. The Call writer's net profit from each Call would be:

-$250 Call writers net profit: Step 1: IV= FP-SP = 375-350 = 25 Step 2: Premium recieved-IV = 20-25 = -5 cents per bushel Step 3: -5 cents*5000 bushels = -25,000 cents Step 4: -25,000 cents / 100 = -$250

Suppose that a trader bought a call option on a stock with strike price $50.00 at premium $2.50 per share. At expiration, the market price of the stock was $52.50. The trader's rate of return on investment is equal to

0% 52.5/(50+2.5) I am not sure if this is the exact formula, pls look up

Consider the same corn farmer in Iowa who expects to harvest 20,000 bushels of corn. The size of CBOT corn futures contract is 5,000 bu. Using historical data, she estimated the risk-minimizing hedge ratio (HR*) which is 0.5. If her objective is to minimize risk, how many corn futures contracts should she short?

2

Suppose that a cotton farmer in Lubbock has planted cotton in April and expecting a harvest of 100,000 lbs. of cotton at the end of September. The current cash price of cotton is 60 ¢/lb. in the local market and the NYBOT October Cotton Futures Price is 60 ¢/lb. The size of NYBOT October Cotton Futures is 50,000 lbs. If the farmer decides to full hedge her expected cash position using a Put option on NYBOT October Cotton Futures with SP = 60 ¢/lb. and premium P = 3 ¢/lb., how many Puts the farmer needs to buy?

2 100,000/50,000=2

Consider the same corn farmer in Iowa who expects to harvest 20,000 bushels of corn. The size of CBOT corn futures contract is 5,000 bu. Using historical data, she estimated the Naive hedge ratio which is 0.75. If she relies on this hedge ration, how many corn futures contracts would she short?

3

Suppose that an oil refiner in Houston refines 10,000 barrels. of Crude oil every month that she procures from the spot market. The current cash price of Crude oil is $35/barrel. in the spot market and the NYBOT June Crude Oil Futures price is $38/barrel. The size of NYBOT Crude Oil Futures is 1,000 barrels. The refiner decides to fully hedge her expected cash position using 10 Call options on NYBOT June Crude Oil Futures with SP = $35/barrel. and premium C = $2/barrel. After 2 months, both cash price and Futures price increase -- CP = $38/barrel. and FP = $40/barrel. What would be the refiner's net cost per barrel of crude oil after purchasing crude oil from the cash market and lifting the hedge? Please enter just the numeric $ value.

35

Suppose that a corn farmer in Iowa expects to harvest 20,000 bushels of corn. The size of CBOT corn futures contract is 5,000 bu. If she wants to hedge her entire cash position, how many corn futures contracts should she short?

4

Suppose that the value of delta for a Put option on a Futures contract is (-0.25). The delta hedge ratio would be

4

If the monthly price volatility of a Put's premiums is 8%, the weekly price volatility of the Put's premiums would be

4% Step 1: 8%*(sq rt of 12)= 0.2771 Step 2: 0.2771/ (sq rt of 52) = 0.0384 Step 3: 0.0384*100= 3.8% which rounds to 4%

Suppose that a cotton farmer in Lubbock has planted cotton in April and expecting a harvest of 100,000 lbs. of cotton at the end of September. The current cash price of cotton is 60 ¢/lb. in the local market and the NYBOT October Cotton Futures Price is 60 ¢/lb. The size of NYBOT October Cotton Futures is 50,000 lbs. The farmer decides to full hedge her expected cash position using a Put option on NYBOT October Cotton Futures with SP = 65 ¢/lb. and premium P = 5 ¢/lb. At the time of harvest, both cash price and Futures price fell -- CP = 55 ¢/lb. and FP = 57 ¢/lb. What would be the cotton farmer's net realized price (¢/lb.) after selling cotton in the cash market and lifting the hedge? Please enter just the numeric value.

58

Suppose that a cotton farmer in Lubbock has planted cotton in April and expecting a harvest of 100,000 lbs. of cotton at the end of September. The current cash price of cotton is 60 ¢/lb. in the local market and the NYBOT October Cotton Futures Price is 60 ¢/lb. The size of NYBOT October Cotton Futures is 50,000 lbs. The farmer decides to full hedge her expected cash position using a Put option on NYBOT October Cotton Futures with SP = 65 ¢/lb. and premium P = 5 ¢/lb. At the time of harvest, both cash price and Futures price increase -- CP = 64 ¢/lb. and FP = 66 ¢/lb. What would be the cotton farmer's net realized price (¢/lb.) after selling cotton in the cash market and lifting the hedge? Please enter just the numeric value.

59

If the weekly price volatility of a Call's premiums is 4%, the monthly price volatility of the Call's premiums would be

8% Step 1: 4%* (square root of 52)= 0.2884 Step 2: 0.2884/ (square root of 12) = 0.0832 Step 3: 0.0832*100 = 8%

After purchasing a call option on a stock, a trader can

Any of the above

If the calculated fair premium of a Put option is higher than the observed premium, an arbitrager would be able to make a risk-free profit by

Buying the Put and Selling the Synthetic Put

A Call option is a contract that gives the buyer (holder) of the contract the right (but no obligation) to purchase a specific asset at a set price on or before the expiration date. The price of the Call option is called the

Call Premium

Suppose that a trader bought a Call option on Corn Futures contract. The strike price, SP = 350 ¢/bu. and the Call premium paid, C = 20 ¢/bu. The size of Corn Futures contract is 5,000 bu. On the expiration date, the market price of the Corn Futures contract appears to be FP= 360 ¢/bu. It would beneficial for the Call holder to:

Exercise the Call Call Option IV= MP-SP IV= 360-350 IV=10 IV>0, therefore exercise the call

Basis risk increases with the correlation between cash and futures prices.

False

Hedging is always beneficial.

False

Hedging is risk-free.

False

If the risk-free interest rate increases, Call premium decreases but Put premium increases.

False

If the volatility decreases, both Call and Put premium increases.

False

Investing with options is less risky than investing with stocks.

False

The call premium increases and put premium decreases as the strike price of the option increases.

False

The objective of hedging is profit maximization.

False

The seller (writer) of a Put option contract is obligated to deliver the underlying asset to the holder in exchange for the Strike Price if the Put holder decides to exercise the right.

False

The time value of an out-of-the-money option on a stock is larger than the time value of the at-the-money option on the same stock with the same expiration date

False

Suppose that a trader bought a Call option on Corn Futures contract. The strike price, SP = 350 ¢/bu. and the Call premium paid, C = 20 ¢/bu. The size of Corn Futures contract is 5,000 bu. On the expiration date, the market price of the Corn Futures contract appears to be FP= 340 ¢/bu. It would be beneficial for the Call holder to:

Let the Call expire Call Option IV=340-350 IV=-10 therefore less than 0 Let the call expire

Suppose that a trader bought a Put option on a Crude Oil Futures contract. The strike price, SP = $45/barrel. and the Put premium paid, P = $5/barrel. The size of Crude Oil Futures contract is 1,000 barrels. One day, the market price of the Crude Oil Futures contract appears to be FP= $42/barrel. If the Put holder exercises the option, the Put writer would receive a

Long position on Crude Oil Futures

Suppose that a trader bought a Call option on Corn Futures contract. The strike price, SP = 350 ¢/bu. and the Call premium paid, C = 20 ¢/bu. The Call option never gained positive intrinsic vale before expiration (Corn Futures price always remained below the SP). However, on the expiration date, the same call option (SP = 350 ¢/bu.) was trading at a premium of C = 20 ¢/bu. It would be beneficial for the Call holder to:

Make an offsetting transaction (i.e., sell the Call)

Suppose that a trader bought a Call option on the stock of Walt Disney Inc. (DIS) with SP = $95/share and paid a Call premium of $7 per share. Assume that one day, before expiration of the Call, the stock started selling at $105/share. At the same time, the same Call option on DIS with SP = $95/share was selling at the premium of $11/share. Which action of the Call holder would be more profitable?

Sell the call option to offset

If the calculated fair premium of a Call option is lower than the observed premium, an arbitrager would be able to make a risk-free profit by

Selling the Call and buying the Synthetic Call

Suppose that you want to synthesize a Bond using the Put-Call Parity relation. The synthetic of the Long Bond would be

Short Call plus Long Put plus Long Stock

Suppose that you want to synthesize a share of stock using the Put-Call Parity relation. The synthetic of the Short Stock would be

Short Call plus Long Put plus Short Bond

A Put option is a contract that gives the buyer (holder) of the contract the right (but no obligation) to sell a specific asset at a set price on or before the expiration date. The set price of the underlying asset in a Put option is called the

Strike Price

An option holder is exposed to limited risk but unlimited profit potential due to changes in the price of the underlying asset.

True

If the market price of a Stock decreases, the Call premium decreases but the put premium increases.

True

If the market price of a share of a Stock is lower than the price of a pure discount Bond with FV=SP of a Call and Put on the Stock, the fair premium of the Call would be lower than the fair premium of the Put.

True

In short hedging, a hedger places hedge against the output price risk by initially taking a short position on a Futures contract and lifts hedge later by offsetting the short position (with long).

True

Short hedging is used to minimize output price risk while long hedging is used to minimize input price risk.

True

Suppose that the value of a Call option's delta is 0.40. It means that if the underlying Futures' price decreases by $1, the Call premium will decrease by $0.40.

True

The maximum profit of an option writer can't exceed the premium received.

True

The net realized price after short hedging or the price paid after long hedging varies with the change in basis.

True

The net return upon short hedging is calculated as the sum of total cash revenue from selling the physical commodity in the cash market and total gain/loss from offset futures transactions.

True

Upon exercising a Call option on a Futures contract, the call holder receives a long position on the Futures contract at the market price at the time of exercise. The Call holder needs to offset the long position before the futures contract expires

True

If a hedger wants to place a short hedging with options on Futures contracts (to protect against a potential output price risk), she needs to take

a long position on a Put option on the Commodity Futures

Price risk can be minimized using

either forward contracts or futures contracts

Suppose that a trader bought a Call option on the stock of Walt Disney Inc. (DIS) with SP = $95/share and paid a Call premium of $7 per share. On the expiration date of the Call, the stock was selling at $99/share. The Call holder would

exercise the option Call option holder: MP>SP 99>95, therefore do exercise

Suppose that a trader bought a Put option on the stock of Walt Disney Inc. (DIS) with SP = $100/share and paid a Call premium of $10 per share. Assume that one day, before expiration of the Put, the stock started selling at $98/share. The Put holder would

exercise the option Exercise call if MP<SP for put option holder 98<100, therefore do exercise

For higher correlation between cash and futures prices, anticipated hedging effectiveness (HE) is

higher.

In long hedging, a hedger places hedge against the input price risk by

initially taking a long position on a Futures contract and lifts hedge later by offsetting the long position (with short)

The activity of trading futures contracts with the objective of minimizing input price risk is called

long hedging

Suppose that a trader bought a Call option on the stock of Walt Disney Inc. (DIS) with SP = $90/share and paid a Call premium of $11 per share. Assume that one day, before expiration of the Call, the stock started selling at $88/share. The Call holder would

not exercise the Call Exercise call if MP>SP for call option holder 88<90, therefore do not exercise

If the absolute value of Basis at the time of lifting a short hedge is larger than the absolute value of Basis at the time of placing the long hedge (that is if the Basis expands), the Price Paid upon long hedging would be

smaller than the cash price at the time of placing hedge

To minimize output price risk by hedging with futures, you need to

take a short position to place hedge

If the absolute value of Basis at the time of lifting a short hedge is smaller than the absolute value of Basis at the time placing the short hedge (that is, if the Basis shrinks),

the Net Realized Price upon short hedging would be higher than the cash price at the time of placing hedge

The net payment upon short hedging is calculated as

total cash payment for purchasing the physical commodity from the cash market minus the total gain/loss from offset futures transactions.