Ch. 10 Options

If an investor with no other positions buys 2 DWQ Jun 45 calls at 3, and he exercises the calls when the stock is trading at 47.25 and immediately sells the stock in the market, what is the investor's profit or loss?

$150 loss The investor exercised the right to buy the stock for 45, and can sell the stock in the market for 47.25 for a gain of 2.25. The gain of 2.25 minus the premium of 3 gives the investor a loss of 0.75 per share. Multiplying the 0.75 loss by 200 (the number of shares) results in a loss of $150.

An investor purchased 100 shares of ABC common stock at $60 per share on March 2, 2019. At the same time, an ABC Oct 55 put was purchased at $2. On June 2, 2020, the investor sold the stock for $85 per share. As a result, the tax consequences are

$2,300 long-term capital gain. The purchase of the put on stock at the same time as the purchase of the stock makes this a married put. This means that the purchase of the put does not affect the holding period of the stock. When the stock was sold in June 2020, the holding period was 15 months, well over the long-term requirement. As far as the math, the cost is $62 per share ($60 cost of the stock plus $2 for the put). The sale price was $85, the gain is $23 per share, $2,300.

With no other positions, a customer sells short 100 TIP at 40 and sells 1 TIP Oct 40 put at 5. At what stock price will the customer break even?

$45 On the downside, the short position fully covers the short put, and the profit is the $500 premium. On the upside, above $40, the short put expires, and the short stock position loses money. The first five points of loss (40 to 45) on the short stock position are offset by the premiums received. Above $45, losses begin and are potentially unlimited

A customer buys 200 XYZ at 39 and writes 2 XYZ Feb 40 calls at 3. When the stock rises to 44, the customer is exercised for a gain of

$800 The customer bought 200 shares at 39 and was forced to sell them at 40 for a $200 gain. In addition, the customer received $600 in premium income, so the overall gain is $800. Alternatively, the breakeven point for covered call writing is cost of shares purchased less premium received (39 − 3 = 36). As the customer is bullish, gain occurs above 36. However, for this customer, the stock can go no higher than 40 because she will be exercised (40 − 36 = 4 points × 200 shares = $800).

Call options allow:

1. Greater leverage than buying underlying stock 2. capital requirements are smaller 3. smaller loss potential The fact that options expire (i.e., have a time value that erodes as the option nears expiration) is a disadvantage of options. Stock purchases have no time value component—there is no expiration and no resulting value erosion.

Short straddle max profit

2 premiums collected

The covered call writing strategy would be most suitable for which of the following investors?

A 65-year-old who is attempting to increase the yield of a portfolio containing equity securities

In, at, and out the money

An option is in the money by the amount of the intrinsic value

Which of the following would be in compliance with the Chicago Board Options Exchange and Options Clearing Corporation rules concerning the nondiscriminatory assignment of an option exercise notice by a firm to one of its customers?

Assignment to the customer with the oldest position in the option You cannot discriminate between large and small customers. First-in, first-out is not considered to be discriminatory.

PIT

Premium- intrinsic value =time value

A customer is long an ABC Apr 40 call and is short an ABC Jul 40 call. Which of the following best describe his position? Bullish Bearish Calendar spread Vertical spread

Bearish & Calendar Spread The July call will have a higher premium than the April call because it has more time value. Because the customer is selling the call with the higher premium, he is counting on the July call to go unexercised, which would allow him to keep the premium as a profit. That means the market value of the underlying security must either stay the same or decline. Therefore, this customer's position is bearish. Because the options expire in different months, the trade is a calendar spread.

Which of the following affects the holding period of XYZ stock, a position that has been held for six months?

Buying an in-the-money put Buy an out-of-the-money put Buying a put (in or out of the money) on a stock held short term (one year or less) erases the holding period until the put is disposed of. At that time, the holding period starts over.

An investor opens the following position: Write 1 CDE Oct 30 call at 3.30 Buy 1 CDE Oct 40 call at .10 The maximum gain is

C) $320 The maximum gain on a credit spread is the net credit received (3.30 − 0.10 = 3.20 × 100 shares = $320).

A customer recently approved to trade options writes an OEX put for the account's initial transaction. If the customer fails to return the signed option agreement within 15 days of account approval, which of the following transactions is the customer permitted to make?

Closing purchase

Covered call writing strategy

Covered call writing is selling calls on stock held in the portfolio. The premium received from the sale represents income. This income adds to whatever other income (dividends) the portfolio is generating. It is a low-risk strategy because the downside movement of the stock is protected to the extent of the premium received Writing covered calls is an active strategy (calls always expire in nine months or less) The strategy would not serve a strongly bullish investor

Short Straddle

Expects stock price stability, collects 2 premiums for selling a straddle (bid price) sell call & put with same strike price & expiration date

Which of the following would protect a short May 50 put?

Long Jun 55 put For a long put to cover a short put, it must have the same or higher strike price and the same or longer expiration

A customer opens the following positions: Buy 100 shares of CDL @$40; sell 1 CDL Apr 40 call @2. What is the customer's maximum gain, maximum loss, and breakeven point?

Maximum gain is $200; maximum loss is $3,800, breakeven point is $38.

Which of the following transactions would be acceptable investments for a pension fund?

Writing a covered call Writing a covered call has less risk than writing a naked option. A covered call writer is merely using options to increase the income on his portfolio. Fiduciaries, such as those who invest for pension fund portfolios, should avoid risky transactions.

On exercise of the option, the holder of a put will realize a profit if the price of the underlying stock

falls below the exercise price minus the premium paid. Breakeven for the buyer of a put is the strike price of the option minus the premium paid for the option.

Individuals with diversified stock holdings in their portfolios write covered calls to

increase their rate of return on the stocks held in their portfolio

The net asset value (NAV) of an international bond fund can be expected to increase if

interest rates fall abroad. the U.S. dollar weakens. If interest rates fall, bond prices will rise, thus increasing the NAV of a bond portfolio. If the U.S. dollar weakens, the value of other currencies will rise. This would also increase the NAV for a portfolio of international bonds.

Put/Call Ratio

ratio of put options to call options outstanding on a stock -IF high, bearish indicator, buying more puts

short straddle max loss

unlimited

If a customer buys 1 ABC Jan 50 call at 2 and 1 ABC Jan 50 put at 4 when ABC is at 49, the maximum potential gain is

unlimited. Maximum gain in a long straddle is unlimited if the market moves up. If the market moves to zero, the gain is $4,400 (50 − 6 = 44).