FIN4650: Derivatives Quiz 2: Chapter 9
The price of a stock is $60. A trader sells 3 call option contracts on the stock with a strike price of $64 when the option price is $5. What is the maximum possible net profit to trader? Hint: Each stock option contract is on 100 shares. A trader selling 3 option contracts implies s/he sold options on 300 shares.
A gain of $1500. Explanation: The trader in this case is the seller of the options. So their maximum profit is the fee collected for selling the option. The maximum gain occurs if the buyer/holder of the options doesn't exercise the options at all. Therefore the trader or seller/writer of the option contracts will keep the entire fee collected up front. aka $5 per option x 300 options = $1500.
Which of the following describes a long position in an option?
A position where option has been purchased.
The price of a stock is $67. A trader sells 5 put option contracts on the stock with a strike price of $70 when the option price is $4. The options are exercised when the stock price is $69. What is the trader's net profit or loss? Hint: Each stock option contract is on 100 shares. A trader selling 5 put option contracts implies s/he sold options on 500 shares.
A gain of $1500. Explanation: Again, ignore the original $67 price - irrelevant for the question. Basically, the trader sold 500 options. Therefore, the trader made $4 per option x 500 options = $2,000 fee collected upfront. Well, since the option was in fact exercised at $69. The trader must buy the stock from the option holder for $70 when the stock is worth $69. 70 - 69 = $1.00. That is a $1.00 loss per option/share for the trader. So the total loss is $1.00 per share x 500 shares or $500. However, the trader still profits because they collected $2,000 up front. Net profit = $2,000 - $500 = $1,500 (Gain)
A call option with a strike price of $50 is selling for an option price of $3. If you have taken a long call position, what is your break-even point?
BREAKEVEN POINT, St = $53 Explanation: You have purchased the option to buy the stock in the future, so you would want the stock price at maturity to be higher than the current strike price. Essentially, you'd get a 'discount' on the purchase of the stock. So, you will exercise the option at any price above $50. However, you will only make a profit if the stock price is above $53 because you already paid $3 for the option itself. :) Thus, $53 is your breakeven point.
Which of the following expresses the payoffs from a LONG PUT?
Max(K-St,0) Explanation: Makes sense. If you have a long put, you bought the option to sell at K in the future. If K = $70, and you exercise when St = $60. Your payoff is expressed as the Maximum between (70-60, 0) -> Max(10, 0) which is $10 because 10 > 0 . Note: this represents payoff, NOT profit. This doesn't take into account the price paid for the option
The price of a stock is $64. A trader buys 1 put option contract on the stock with a strike price of $60 when the option price is $10. When does the trader make a profit?
Profits when the stock price is below $50. Explanation: - Ignore the price of the stock ($64) irrelevant for the question. - The trader bought the right to sell the stock at $60, and he paid $10 for that option. Basically, the trader will exercise this option at any price below $60, however will only profit if the stock price is below $50 because that will account for the $10 fee he paid up front for the option.
An investor has exchange-traded put options to sell 100 shares for $20. There is a 2-for-1 stock split. Which of the following is the position of the investor after the stock split?
Put options to sell 200 shares for $10. Explanation: 2-for-1. You get 2 shares for everyone 1 that you have. So you take 100 x 2 = 200 shares. Well, that means the price needs to be divided by 2 to account for doubling the amount of shares. So, $20 / 2 = $10.
Which one of the following positions is most suitable if you feel that the price of the underlying asset in the future is not likely to rise above $120 (in other words, you expect future asset price to be $120 or below).
Short Call with K = $120. Explanation: Essentially, you don't think the option will be exercised so you'll keep the fee collected for selling this option to someone.
Consider a long put option with a strike price of $50 and option price of $5. Under what range of stock-prices, will this option be exercised?
St < $50 Explanation: This option will be exercised if the stock price is below $50. This is because a long put option gives you the option to sell the stock for a certain price in the future. & you are hoping to sell it for more than it is worth. In this case, you get to sell the stock at $50 in the future, and you paid $5 for the right to do that. Well, you want the stock price to be below $45 (strike price minus the option fee you paid), so that you make a profit by selling it at $50. If the stock price is $40 when you exercise this option, you will make a $10 payoff, but a $5 overall profit after you subtract the option fee.
A trader bought 1 call option contract on a stock with a strike price of $50 when the option price was $6. The price of a stock is currently $45. Which of the following is true?
The option is out-of-the-money Explanation: Out-of-the-money, because if you exercised it right now you would not make any money. Basically, you wouldn't exercise this option at this point. Because, why would you want to exercise this option and buy the stock for $50, when you can just buy it for $45 at the current stock price.
