Module 09: Options Quiz 1
An investor buys 100 shares of EGG at $27 per share and at the same time writes an EGG 30 call for a premium of $7. At what price would EGG have to be selling for the writer to incur a loss?
Correct Answer: A. $19 $19. Net the cost of the stock (-27) and the premium received (+7) to find the breakeven of $20. Set it up this way: ---30--- Long stock -27 + Short 30 call +7 20 BE 20 BE - When the stock trades below $20 per share, the investor will incur a loss. The only answer choice under $20 is $19.
An investor sells an RQP 50c for a premium of 7. What is the maximum loss the writer could have just prior to the expiration date?
Correct Answer: D. Unlimited Unlimited. To calculate this, write down the strike price of 50. Since this is a call, add the premium of 7 to the 50 to find the breakeven point, BE, of 57. Since the investor writes the call and receives the premium, slide the + sign between the strike price and the BE. Put a minus (-) above the 57. It looks like this: - 57 BE + ---50--- Because the stock could rise indefinitely, the investor's potential loss is unlimited.
An investor who buys a put option would make the most money when the stock is:
Declining in market value. Investors who buy a put are betting the market will decrease in price so they can go out into the open market and buy the stock at a low price and then sell the stock to the writer of the put at the agreed upon higher price. If they are able to do this, they buy the stock at a low price and sell it at a high price, so they make money.
A call option is said to be in the money when the market price of the underlying security is:
Higher than the strike price. A call option is in the money when the market price of the stock is higher than the strike price, or lower than the strike price on a put. So the "lower than the strike price" choice would be accurate if the question asked about a put option. Always consider this from the point of view of the owner of the option. When the owner is able to exercise, the option is in the money. Remember, though, that it is the option that is in the money, not the buyer or the writer. Calls are always in the money when the market price is higher than the call option's strike price, even if the investor is the writer. Again, just remember -- call up, put down. Calls are in the money when the stock price is higher than the strike price. Puts are in the money when the stock price is lower than the strike price.
Which of the following are in the same class of options? I. An RCA March 45 put and an RCA March 40 put II. An RCA March 45 call and an RCA March 40 call III. An RCA March 45 put and an RCA March 40 call IV. An RCA March 40 call and an RCA March 40 put
I and II. March 45 put and March 40 put, and March 45 call and March 40 call. To have the same class of options, both options must be calls or both must be puts. That the options are in the same class indicates that they are the same type of option -- meaning more than one put or call. Choices III and IV have both a put and a call, so they are not in the same class -- they are straddles.
Which two of the following form a straddle? I. Long XYZ AP 60 call II. Short XYZ AP 60 call III. Short XYZ AP 50 put IV. Long XYZ AP 60 put
I and IV. A straddle is a put and a call (either written or bought) with the same stock, strike price, and date. There is no name for a combination of option positions with the same strike price and date but different underlying securities. If either the price or date is different, but the stock is the same, the investment strategy is called a combination straddle.
David sells 5 EGG Nov 50 put for 13 and buys 5 EGG Nov 40 put for 8. Which of the following statements are true? I. This is a bullish position. II. This is a bearish position. III. This is a debit spread. IV. This is a credit spread.
I and IV. This is a bullish position and a credit spread. If you write these down, with the higher strike price on top, it looks like the following: Short 50 put +13 Long 40 put -8 +5 Because the plus premium is the higher strike price, this is a bullish spread. All you need to do is to look at where the plus sign is in the diagram -- since the higher strike price is on top and the signs slide over, the plus is on top. This shows that the investor wants the stock to rise, so he is bullish. Since the net premium is positive (+5), it is a credit spread.
An investor buys an EGG June 25 call and an EGG June 25 put. The investor's position is best described as a:
Long straddle. When an investor has a put and a call on the same stock at the same price with the same expiration date, it is called a straddle. If either the date or the strike price is different, it is called a combination. Since the investor is buying, it is a long straddle. If the investor had written (sold) the straddle, it would be called a short straddle. A spread refers to buying and writing a call or buying and writing a put (both options are of the same class).
Shirley buys a May 90 put and sells a July 90 put. What does Shirley want the difference in the premiums to do?
Narrow. Since the question gives no premiums, you must make them yourself. We always use 4 and 6. The larger one must be assigned to the longer option, and since the July option is longer than the May option, the July has the 6. The investor sells the July and buys the May, so +6 + -4 = +2. Since she is ahead (+), she wants the difference to narrow.
Which of the following statements is true of a 240 put index option when the market is at 235? A. The option has intrinsic value. B. The option is out of the money. C. The time value equals the premium. D. The premium is equal to the intrinsic value.
The option has intrinsic value. This is because the value of the index is lower than the strike price. Being in the money, or having intrinsic value, occurs when the market is below the strike in a put or the market is above the strike price in a call. There is not really a market price for index options, but rather an index value. If you are having trouble, draw an H diagram. Enter the strike price on the cross line of the "H." Since this is a put, enter "P" for put below the line. Now enter the price of the index. Since 240 is on the line and the index is at 235, below the line, the index put option is in the money, or has intrinsic value.
An investor sells an Aug 40 call and buys an Aug 50 call. This position can best be described as a:
Vertical spread. Since the months are the same but the prices are different, this is a vertical spread, also called a price spread.
A customer buys 3 General Motors March 70 calls and pays a $4 premium on each. General Motors is currently trading at $73 per share. How much money does the customer have to deposit?
$1,200. When investors buy an option, they must pay the full premium. In this case, the investor is buying 3 calls with a premium of $4 per share per option. Since each option contract has 100 shares, 3 x $4 x 100 shares = $1,200 total premium needed.
A customer buys 5 FMC 80 calls and pays a premium of 5 on each call. The current market price of FMC is $81 per share. If the market price of FMC falls to $76 and the calls expire without being exercised, the customer would lose:
$2,500. The buyer of the call option can only lose the premium -- no more. The customer can earn a tremendous amount, but can only lose the premium. In this case, 5 x the $500 premium = $2,500.
A customer buys a U.S. Steel May 40 put when the market price of U.S. Steel is at $40 per share and pays a premium of $3. If the stock declines to 35 and the investor exercises the put, what is his gain or loss?
$200 gain. To calculate the answer, write the strike price of the put, 40, with a line through it. Because it is a put, subtract the premium, 3, from 40 to find the breakeven, 37, and label it breakeven. Since the premium has been paid, the investor is minus (-) money, so slide that sign between the strike price and the breakeven. Then insert a plus sign below the breakeven point and insert the market price of the stock. Because the stock is at 35 on the plus side, and it is two points below the breakeven of 37, the investor has a two-point gain. For 100 shares, the gain is $200. Diagram the problem as follows: --- 40 --- - 37 BE + 35 market price of the stock
A customer buys an RCA Sept 40 call for a premium of 6 and an RCA Sept 40 put for a premium of 1. At expiration RCA is trading at $49 per share and the put option expires unexercised; however, the customer exercises the call option part of the straddle. The customer has a net:
$200 profit. To calculate this, write the strike price of 40 and put a line through it. Since the investor buys both positions, the strategy is called a straddle. The investor pays a total of $7 for the positions and needs to recoup this amount to break even. The investor is "minus" (-) the total premium. Because this strategy involves a call and a put, add the 7 to 40 for the call and subtract 7 from 40 for the put to find the breakeven points at 47 and 33. Label both of these prices, "breakeven." It should look like this: 49 market price + 47 BE - ---40--- - 33 BE + RCA rises to 49, which is higher than 47 in the plus area, and the investor will have a gain. 49 - 47 = 2, so the option investment has a 2-point gain: $2 x 100 shares = a $200 profit.
A customer buys three General Motors March 70 calls and pays a $4 premium on each call. General Motors is currently trading at $73 per share. What is the buyer's breakeven point?
$74. Think call up! The buyer of the call wants the stock to rise in price so he can buy the stock at the call price and then sell it in the open market. To determine the breakeven point, add the premium to the call price. In this case, the strike price is 70, the premium is 4, so the break even is 74.
Listed index options expire:
10:59 p.m. Central Time (11:59 p.m. Eastern Time) on the Saturday after the third Friday of the month in which they expire. Options trading stops at 3 p.m. Central Time (4 p.m. Eastern Time) on the third Friday of the month in which they expire. 4:30 p.m. Central Time (5:30 Eastern Time) is the last time that notice can be given to exercise. Foreign currency options expire at 10:59 p.m. Central Time (11:59 p.m. Eastern Time) on Saturday before the third Wednesday of the month in which they expire.
A customer of yours trades options. He would like to enter an order to sell 20 BMR 70 calls for a premium of at least 10. Prior to the order being executed, BMR stock begins to trade ex-dividend in the amount of a 25% stock dividend. How would the order now read?
20 BMR 56 calls for 8. This is called an odd stock split. The number of option contracts remains the same, but the strike price and the premium both decrease, accordingly. The number of shares increases in an odd stock split. If the number of shares of stock granted as a dividend represents an even stock split, the number of contracts associated with each option contract would increase. The strike price and premiums would decrease as well. Remember that the contracts stay the same in odd stock splits, and the contracts increase in even stock splits. Strike prices and premiums are always reduced.
An investor owns a German deutschmark 48 put option for which he paid a premium of $0.63. What is his breakeven?
47.37. To determine the breakeven, "put down." In this case, the option is a 48 put for a premium of .63, so 48 - .63 = 47.37. Currency options are similar to equity options; the option terms are used interchangeably.
An investor purchases 500 shares BMF stock at $63 per share. Three months later, the stock is selling for $86 per share. The investor reads in the newspaper that BMF is having financial troubles with its new product and is concerned that the stock may decline. As his registered rep, what would you suggest to the investor?
Buy 5 puts on BMF stock with a strike price of 80. This investor is concerned with a drop in the price of the BMF stock and would like to protect his profit. In other words, the investor needs "downside protection." Because the investor is long stock, he needs an option that allows him to sell the stock at a set price. A long put allows him to sell stock, so when he purchases at an 80 strike price, he is protecting his gain.
