Options

To speculate on a rising interest rate environment, the strategy that would give the largest profit is to: A. Buy TYX calls B. Sell TYX calls C. Buy TYX puts D. Sell TYX puts

The best answer is A. Interest rate option premium movements are based on the movement of market interest rates. The TYX index option is based on the interest rate movement of the most recently auctioned 30-year Treasury Bond. To speculate on market interest rates rising, calls should be purchased. As market interest rates keep rising, the call premium keeps increasing. Note that selling a TYX put will also produce a profit in a rising interest rate environment because the put will expire "out the money" and the premium will be earned. But this strategy produces a fixed profit in a period of rising interest rates, while buying an interest rate call gives an ever-increasing profit as market interest rates rise.

A customer buys 1 Euro Feb 142 Call and sells 1 Euro Jan 142 Call. The position is profitable if: A. the spread between the premiums widens B. the spread between the premiums narrows C. both contracts are exercised D. both contracts expire "out the money"

The best answer is A. The February expiration must be the month immediately following January. It cannot be the other way around, because then the time between the 2 expirations would be 11 months (February followed by January 11 months later). Since the maximum life of regularly issued options is 9 months, this cannot be the case. Thus, the February expiration must be later than the January expiration, with the February expiring 1 month after the January. The customer is buying the "far" expiration (February) and selling the "near" expiration (January) in this calendar spread. Because of its higher time value, the far expiration must be more expensive, so this is a debit spread. Debit spreads are profitable if the spread between the premiums widens. Then the positions can be closed out at a larger net credit. In this case, exercising both contracts will not result in a gain because the strike price is the same for both. If both contracts expire, the customer loses the net debit. If both contracts are exercised, the customer buys Euros at $1.42 and delivers them for $1.42, incurring commission costs without any gain on the currency.

A Japanese exporter of electronic equipment to the United States is paid in U.S. Dollars when the equipment arrives in the U.S. The exporter wishes to protect against an adverse currency move in the PHLX World Currency Options market. The appropriate hedge is to buy: A. Japanese Yen Calls B. Japanese Yen Puts C. Currency Index Calls D. Currency Index Puts

The best answer is A. The Japanese exporter is being paid in U.S. dollars. If the dollar weakens against the Japanese Yen, then the exporter will receive fewer Japanese Yen when he or she converts the U.S. Dollars received into Yen. To protect against an adverse move, the exporter should buy U.S. Dollar Puts - however this is not a choice, since no U.S. Dollar options are traded on the PHLX! The risk here is that the Dollar will fall against the Yen; this is the same as the Yen strengthening against the Dollar. Thus, an equivalent hedge would be to buy Japanese Yen Calls. If the Yen appreciates against the Dollar, the gain on the Yen Calls would offset any loss on the Dollars received in payment. A currency index call or put would not move at the same rate as a single currency, making this less useful as a hedge. Furthermore, there are no PHLX traded currency index options.

A Japanese company has entered into a contract to deliver goods to New York, payable in U.S. dollars upon delivery. To hedge the position using the PHLX World Currency Options market, the Japanese company should: A. buy Japanese Yen calls B. buy Japanese Yen puts C. sell Japanese Yen calls D. sell Japanese Yen puts

The best answer is A. The Japanese exporter is being paid in U.S. dollars. If the dollar weakens against the Japanese Yen, then the exporter will receive fewer Japanese Yen when he or she converts the U.S. Dollars received into Yen. To protect against an adverse move, the exporter should buy U.S. Dollar Puts - however this is not a choice, since no U.S. Dollar options are traded on the PHLX! The risk here is that the Dollar will fall against the Yen; this is the same as the Yen strengthening against the Dollar. Thus, an equivalent hedge would be to buy Japanese Yen Calls. If the Yen appreciates against the Dollar, the gain on the Yen Calls would offset any loss on the Dollars received in payment. A currency index call or put would not move at the same rate as a single currency, making this less useful as a hedge. Furthermore, there are no PHLX traded currency index options. Instead of buying Yen calls, the exporter could sell Yen puts; and if the Yen appreciates, the puts would expire and the premium received could be used to offset any loss on the Dollars received in payment. However, this only hedges the importer to the extent of the premium collected; therefore, buying Japanese Yen calls is the better choice

When the market price of XYZ stock is $44 per share, which of the following choices would create a "strangle"? A. Short 1 XYZ Jan 40 Put; Short 1 XYZ Jan 50 Call B. Long 1 XYZ Jan 50 Put; Long 1 XYZ Jan 40 Call C. Long 1 XYZ Jan 50 Call; Long 1 XYZ Jan 50 Put D. Short 1 XYZ Jan 40 Call; Short 1 XYZ Jan 40 Put

The best answer is A. A "strangle" is a specific variation of a combination, where both contracts are "out the money." Choice C is a long straddle; Choice D is a short straddle. Straddles have the same strike price and expiration. Combinations have different strike prices and/or expirations. A long strangle is the purchase of an "out the money" call and an "out the money" put. The "idea" behind the strategy is to profit from a volatile market, just like a long straddle. Because both contracts are "out the money," the premium cost will be lower. However, the market must move more sharply (either up or down) in order for the position to be profitable. Choice B is not a long strangle because both positions are "in the money." A short strangle is the sale of an "out the money" call and an "out the money" put. The "idea" behind the strategy is to profit from a stable market, just like a short straddle. Because both contracts are "out the money," the premiums collected will be lower. However, the market must move more sharply (either up or down) in order for the position to become unprofitable. Choice A is a short strangle because both positions are "out the money."

Which of the following is/are traded over-the-counter in the "interbank" market? I Foreign currencies II Foreign currency options III Stocks IV Stock options A. I only B. I and II only C. I and III only D. II, III, IV

The best answer is A. All options are exchange traded - stock options, index options, foreign currency options and debt options. However, the trading of foreign currencies themselves takes place over-the-counter in the "interbank" market.

A customer purchases an equity option contract at 1:00 PM Eastern Standard Time on Tuesday, October 10th in a regular way trade. If the customer wishes to exercise, the customer may place an exercise notice with the Options Clearing Corporation: A. immediately B. no earlier than 10:00 AM Eastern Standard Time, the next business day C. no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D. no earlier than the Friday immediately preceding the third Saturday of the expiration month

The best answer is A. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation does not handle the exercise until the morning of the next business day (which is also the day that the customer must pay for the option contract). This procedure is followed because the Options Clearing Corporation does not receive the report of the purchase of the option until the close of trading on the day that the contract is purchased. The O.C.C. opens the next day with the customer recorded as being "long" that contract, and can now assign an exercise notice to a writer.

A customer purchases an equity option contract at 1:00 PM Eastern Standard Time on Tuesday, October 10th in a cash trade, and files an exercise notice at 3:00 PM on the same day. The option contract will first be exercised by the Options Clearing Corporation: A. immediately B. no earlier than 10:00 AM Eastern Standard Time, the next business day C. no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D. no earlier than the Friday immediately preceding the third Saturday of the expiration month

The best answer is A. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. The Options Clearing Corporation does not assign the exercise until the transaction settles, which is the same day for a cash trade. Once the assignment occurs, the stock must be delivered to the holder of the call; or the stock must be delivered to the writer of the put; 2 business days after assignment.

If an index option is exercised, the holder's account will be: A. credited the "in the money" amount B. credited the "out the money" amount C. debited the "in the money amount" D. debited the "out the money" amount

The best answer is A. An option will only be exercised if it is in the money. Index option exercise settles in cash. The holder's account is credited the in the money amount while the writer's account is debited the "in the money" amount.

Which of the following persons trades securities for his own account? I Specialist (DMM) II Market Maker III Order Book Official IV Floor Broker A. I and II B. II and IV C. I, II, III D. I, II, III, IV

The best answer is A. Both the Specialist (now called the DMM - Designated Market Maker) on the NYSE floor; and the Market Maker on the CBOE floor are dealers who buy and sell designated securities into their inventory and from their inventory. Floor brokers handle public orders on the NYSE floor acting as agent only - they do not trade for their own account. Order Book Officials ("OBOs") on the CBOE floor handle the book of public orders that are "away" from the current market.

A customer buys 1 ABC Jan 30 Call @ $12 and sells 1 ABC Jan 45 Call @ $3 when the market price of ABC is $38. The maximum potential gain is: A. $600 B. $900 C. $1,500 D. unlimited

The best answer is A. Bull call spreads (long call spreads are bullish strategies) are profitable if the market rises. If the market rises, both contracts are exercised for a 15 point gain (buy at $30 and sell at $45) offset by the net premium paid of 9 points. Thus, the maximum potential gain is: 15 - 9 = 6 points or $600.

Which of the following are TRUE statements regarding index options? I Upon exercise, the writer must pay to the holder the "in the money amount" II Settlement upon exercise occurs next business day III Settlement is based on the index value at the time of exercise IV The maximum risk for an index option writer is the loss of the premium A. I and II B. II and III C. I, II, III D. II, III, IV

The best answer is A. If an index option is exercised, the writer must pay the holder the "in the money" amount the next business day. There is no delivery of the stocks that are in the index - these are termed "cash settled options." The index value is computed as of the close the day of exercise. The writer of an index call has unlimited risk; the writer of an index put has increasing risk as the market drops.

On the same day in a margin account, a customer buys 5 ABC January 40 Calls @ $6 and sells 10 ABC January 50 Calls @ $1 when the market price of ABC is at $43. If the market moves to $48 and the contracts are closed at intrinsic value, the gain or loss is: A. $2,000 gain B. $2,000 loss C. $2,500 gain D. $2,500 loss

The best answer is A. If the market moves to $48, and the contracts are closed at intrinsic value, the short 50 calls expire since they are "out the money." On the long 40 calls, the customer will have a gain of 8 points per contract. Thus, the customer will gain $800 per long call x 5 contracts = $4,000. Since the customer paid a true net debit of $400 per contract (5 points per spread - 1 point received on each of the naked calls) x 5 contracts = $2,000 paid, the net profit is $2,000.

A customer sells short 100 shares of DEF stock at $63 and sells 1 DEF Oct 60 Put @ $6. The market rises to $68 and the put expires. The customer buys the stock in the market covering her short stock position. The gain or loss is: A. $100 gain B. $100 loss C. $300 gain D. $300 loss

The best answer is A. If the market rises, the short put expires. Here, the customer buys the stock at $68 to cover her short stock position that was originally sold at $63. There is a 5 point or $500 loss, that is offset by the $600 in premiums received. Thus, there is a net gain of $100.

A customer buys 1 OEX Jan 530 Put @ $3. The overall market falls and the index closes at 529, while OEX 530 Put contracts close at $4.50. Which is the most profitable action? A. Close the position B. Exercise the position C. Let the position expire D. Roll-up the position

The best answer is A. If the position is closed, the customer makes 1.50 points (Bought at $3; Sold at $4.50) = $150. If the position were exercised, the writer must pay the holder the "in the money" amount. This is a 530 Put when the index value is at 529 = 1 point "in the money" times a multiplier of 100 = $100 to be paid from writer to holder. Since a $300 premium was paid by the holder, the net loss is $200, resulting from the exercise. If the position expires, the holder loses the $300 premium paid. The last choice, "rolling-up the position" is an advanced strategy that is not tested.

An exporter of goods to Japan is going to receive 1 million Japanese Yen in payment. To protect against a decline in the Yen, the customer would hedge by purchasing how many World Currency contracts? A. 1 B. 10 C. 100 D. 1,000

The best answer is A. PHLX World Currency options cover 10,000 units of currency, with the exception of the Japanese Yen contract, which covers 1,000,000 units of currency. Since this customer is long 1,000,000 Japanese Yen, and each put contract covers 1,000,000 Yen, only 1 contract is needed to hedge the long foreign currency position from a market decline.

A customer buys 1 XMI Feb 500 Put @ $4 when XMI closes at 497. The time value in the premium is: A. 1 point B. 2 points C. 3 points D. 4 points

The best answer is A. Since the put contract allows the holder to sell XMI at 500 when XMI is worth 497, the contract is "in the money" by 3 points. Remember, puts go "in the money" when the market drops. Of the total 4 point premium, 3 points are "intrinsic value." The balance of the premium (1 point) is "time premium."

When the Euro is trading at $1.39, a customer takes the following positions: Buy 1 PHLX Jan Euro 140 Put Sell 1 PHLX Jan Euro 135 Put This is a: A. bear put spread B. bull put spread C. horizontal put spread D. diagonal put spread

The best answer is A. The long 140 Put is "in the money" when the market is at 139, while the short 135 put is "out the money." Therefore the premium on the long put must be higher than the premium on the short put so this is a debit spread (long premium higher than short premium). In a debit spread, the customer is a net buyer of the position, so this is a long put spread. Long put spreads are profitable if the market drops, so this is a bear strategy.

A customer buys 100 shares of ABC stock at $50 and sells 1 ABC Jan 50 Call @ $4 and sells 1 ABC Jan 50 Put @ $3. The customer's maximum potential gain is: A. $700 B. $4,300 C. $9,300 D. Unlimited

The best answer is A. This customer has a long stock position with a short straddle. The customer believes that the market will remain flat for the life of the options; and the customer will collect the total premium of $700. If the market rises above $50, the short call is exercised and the short put expires. In this case, the customer must deliver the 100 shares owned for $50 received per share. Since the customer paid $50 per share, the only gain is the combined $700 premium received. On the other hand, if the market falls, the short put is exercised and the short call expires. The exercise of the short put obligates the customer to buy 100 shares of ABC stock at $50, in addition to the 100 shares already owned at $50. In a falling market, the customer will lose on the 200 shares of ABC - with the maximum loss being $50 paid per share x 200 shares = $10,000 - $700 collected premiums = $9,300.

On the same day, a customer buys 100 shares of XYZ stock at $60 and sells 1 XYZ Nov 60 Call @ $6 and sells 1 XYZ Nov 60 Put @ $2. The customer's maximum potential gain is: A. $800 B. $5,200 C. $11,200 D. Unlimited

The best answer is A. This customer has a long stock position with a short straddle. The customer believes that the market will remain flat for the life of the options; and the customer will collect the total premium of $800. If the market rises above $60, the short call is exercised and the short put expires. In this case, the customer must deliver the 100 shares owned for $60 received per share. Since the customer paid $60 per share, the only gain is the combined $800 premium received. On the other hand, if the market falls, the short put is exercised and the short call expires. The exercise of the short put obligates the customer to buy 100 shares of XYZ stock at $60, in addition to the 100 shares already owned at $60. In a falling market, the customer will lose on the 200 shares of XYZ - with the maximum loss being $60 per share x 200 shares = $12,000 - $800 collected premiums = $11,200.

A customer buys 1 ABC Jan 50 Call and sells 1 ABC Nov 50 Call. This is a: A. calendar debit spread B. calendar credit spread C. vertical debit spread D. vertical credit spread

The best answer is A. This is a horizontal or calendar spread, where the positions have the same strike price, but different expirations. Since the maximum life of a regular stock option is 9 months, the November contract must be closer to expiration than the January - that is, if it is now November, the January contract is 2 months farther out. The January option cannot be the closer expiration, since the following November is 10 months away. Since Nov expires before Jan, it will be cheaper. The customer is selling the Nov 50 Call (cheaper) and buying the more expensive Jan 50 Call, so this is a debit spread.

ABC corporation is trading in the market for $51. The corporation declares a 25% stock dividend. After the ex date, the holder of 1 ABC Jan 50 Call will have: A. 1 ABC Jan 50 Call B. 1.25 ABC Jan 50 Calls C. 1 ABC Jan 40 Call D. 1.25 ABC Jan 40 Calls

The best answer is A. This is a stock dividend of 25%. The OCC does not adjust the contract on ex date. Only if there is an exercise, then the OCC adjusts the "deliverable." The contract holder owns 1 ABC Jan 50 Call. If the contract is exercised, the holder will receive 100 x 1.25 = 125 shares; at a price of $50/1.25 = $40.

A customer sells short 100 shares of ABC stock at $40 and buys 1 ABC Mar 40 Call @ $5. The maximum potential loss is: A. $500 B. $3,500 C. $4,500 D. unlimited

The best answer is A. The long call limits loss on the short stock position in a rising market. The stock was sold for $40 and can be bought back at $40 by exercising the call. The only loss to the customer is the premium paid of 5 points or $500.

Which of the following positions are profitable in bull markets? I Debit Call Spread II Credit Call Spread III Debit Put Spread IV Credit Put Spread A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Long Calls are profitable in rising markets, as are Long (Debit) Call Spreads. In a Long Call Spread, the lower strike price call is purchased and the higher strike price call is sold. This is a debit spread because the lower strike price call being purchased is more expensive than the higher strike price call being sold. If the market rises, the long call is exercised and the stock is purchased at the lower price. If the market keeps on rising, the short call is exercised and the stock is sold at the higher price, for a profit. Short Calls are profitable in falling markets, as are Short (Credit) Call Spreads. In a Short Call Spread, the lower strike price call is sold and the higher strike price call is purchased. This is a credit spread because the lower strike price call being sold is more expensive than the higher strike price call being purchased. If the market falls, both positions expire and the credit is kept. Long Puts are profitable in falling markets, as are Long (Debit) Put Spreads. In a Long Put Spread, the higher strike price put is purchased and the lower strike price put is sold. This is a debit spread because the higher strike price put being purchased is more expensive than the lower strike price put being sold. If the market falls, the long put is exercised and the stock is sold at the higher price. If the market keeps on falling, the short put is exercised and the stock is bought at the lower price, for a profit. Short Puts are profitable in rising markets, as are Short (Credit) Put Spreads. In a Short Put Spread, the higher strike price put is sold and the lower strike price put is purchased. This is a credit spread because the higher strike price put being sold is more expensive than the lower strike price put being purchased. If the market rises, both positions expire and the credit is kept.

On the same day, a customer sells 1 ABC Jan 50 Call @ $5 and buys 1 ABC Jan 60 Call @ $2. The maximum potential gain is: A. $200 B. $300 C. $700 D. unlimited

The best answer is B. The customer has created a short call spread, which is profitable if the market price stays the same or falls. Sell 1 ABC Jan 50 Call @ $5 Buy 1 ABC Jan 60 Call @ $2 $3 Credit The maximum potential gain is the credit. This will happen if the market goes to $50 or below and both calls expire.

On the same day in a margin account, a customer sells 5 ABC January 40 Calls @ $6 and buys 10 ABC January 50 Calls @ $1 when the market price of ABC is at $43. The maximum potential loss is: A. $2,000 B. $3,000 C. $5,500 D. unlimited

The best answer is B. This customer has bought 10 ABC Jan 50 Calls @ $1 ($1,000 premium paid) and has sold 5 ABC Jan 40 Calls @ $6 ($3,000 premium collected). In this case, if the market falls below $40 and all of the calls expire "out the money," the customer will gain $2,000 (Sell 5 Calls @ $6 for $3,000 profit offset by the purchase of the 10 Calls @ $1 or $1,000: $3,000 received - $1,000 paid = $2,000 profit). If the market rises to $50, the customer will have the maximum potential loss. At $50, the short 5 ABC Jan 40 Calls are exercised, obligating the customer to deliver 500 shares @ $40 each. The customer is long 10 ABC Jan 50 Calls, which expire "at the money." Therefore, the customer will buy 500 shares in the market @ $50 to deliver, losing $10 per share, or $5,000 on 500 shares. Since the beginning net credit was $2,000, the customer loses $3,000. Above $50, all contracts are "in the money" and are exercised. The short 5 ABC Jan 40 Calls that are exercised are satisfied by exercising 5 of the long ABC Jan 50 Calls. On the remaining long 5 ABC Jan 50 Calls, there is a profit as the market continues to move higher than $50. If the market keeps on rising, there is unlimited gain potential.

ABC Corporation, after many profitable years, declares a one-time special cash dividend of $10.00 per share. After the announcement, the stock is trading at $100 per share. Your customer holds 1 ABC Jan 110 Call. As of the ex date, the customer will have: A. 1 ABC Jan 90 Call B. 1 ABC Jan 100 Call C. 1 ABC Jan 110 Call D. 1 ABC Jan 120 Call

The best answer is B. While the OCC does not adjust the strike prices of listed options contracts for regular quarterly cash dividends, since they are a "known quantity" that the market prices into options premiums, "special cash dividends" are a one-time event that the market does not know about. Therefore, the OCC does adjust listed options for special cash dividends that amount to at least $12.50 per contract. Since this special cash dividend amounts to $10 per share x 100 shares = $1,000 value per contract, it will be adjusted. The new strike price will be 110 - $10 cash dividend = 100. The number of shares covered by the contract does not change.

A customer who is long 1 ABC Jan 55 Call wishes to create a "long call spread." The second option position that the customer must take is: A. short 1 ABC Jan 45 Call B. short 1 ABC Jan 65 Call C. short 1 ABC Jan 45 Put D. short 1 ABC Jan 65 Put

The best answer is B. A spread is a buy and a sell of the same type of option. Since the customer is already long a call, he or she must be short a call to create a spread. In order for the position to be a "long call spread," the customer must be a net buyer, meaning he or she must purchase the more expensive contract and sell the less expensive one. Since the lower strike price contracts are worth more money (for calls, since it is more advantageous to buy cheaper), he must sell the higher strike price contract to be a net buyer of the position. In this case, since the customer is already long a Jan 55 Call, to create a spread, a higher strike price call must be sold - and the only choice given that meets this criteria is to sell a Jan 65 Call. This is a moderately bullish strategy.

Which of the following are vertical spreads? I Long 1 ABC Jan 50 Put Short 1 ABC Jan 50 Put II Long 1 ABC Jan 50 Put Short 1 ABC Jan 60 Put III Long 1 ABC Jan 50 Put Short 1 ABC Apr 50 Put IV Long 1 ABC Jan 50 Put Short 1 ABC Apr 60 Put A. I only B. II only C. I and III D. II and IV

The best answer is B. A vertical spread (also called a "price" spread) is the purchase and sale of a call; or the purchase and sale of a put; at different strike prices. A horizontal spread is the purchase and sale of a call; or the purchase and sale of a put; at different expirations. A diagonal spread is the purchase and sale of a call; or the purchase and sale of a put; with both different expirations and different strike prices.

Which statements are TRUE about the CBOE Order Support System? I The order is directed to the brokerage firm's communication post on the exchange floor II The order is directed to the trading post III Execution notices are sent directly from the trading post to the brokerage firm A. I and III B. II and III C. I only D. I, II, III

The best answer is B. All automated trading systems function in a similar fashion. Orders are routed directly to the trading post, eliminating the need for the order to be wired to the communication post on the exchange floor and then written by hand to be given to a floor broker. The execution report is sent directly to the originating firm; it does not go through the firm's communication post.

A customer places an order to sell 5 ABC Feb 50 straddles at the market. The CBOE market maker's quotes for ABC 50 contracts are: ABC Call Put 50.50 Bid Ask Bid Ask Jan 50 2.00 2.25 .75 1.00 Feb 50 3.00 3.25 1.00 1.25 Mar 50 4.00 4.25 1.25 1.50 The customer will receive a total premium of: A. $1,800 B. $2,000 C. $2,125 D. $2,500

The best answer is B. An ABC Feb Straddle consists of: 1 ABC Feb 50 Call 1 ABC Feb 50 Put If a straddle is bought, the buyer pays the "Ask" price of the market maker on the exchange floor. If a straddle is "sold," the seller receives the "Bid" price of the market maker. In this case, the customer is selling the straddle, so the premiums are: Sell 1 ABC Feb 50 Call @ $3 Sell 1 ABC Feb 50 Put @ $1 $4 Credit = $400 per contract x 5 contracts = $2,000 The total premium received will be $2,000.

A customer purchases an equity option contract in a regular way trade at 1:00 PM Eastern Standard Time on Tuesday, October 10th, and files an exercise notice at 3:00 PM on the same day. The option contract will first be assigned by the Options Clearing Corporation: A. immediately B. no earlier than 10:00 AM Eastern Standard Time, the next business day C. no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D. no earlier than the Friday immediately preceding the third Saturday of the expiration month

The best answer is B. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation does not handle the exercise until the morning of the next business day (which is also the day that the customer must pay for the option contract in a regular way settlement). This procedure is followed because the Options Clearing Corporation does not receive the report of the purchase of the option until the close of trading on the day that the contract is purchased. The O.C.C. opens the next day with the customer recorded as being "long" that contract, and can now assign an exercise notice to a writer.

A customer buys a listed stock option in a regular way trade and exercises that same day. The Options Clearing Corporation will assign the exercise notice to a writer on: A. that day B. the next business day C. the 2nd business day after exercise date D. the 5th business day after exercise date

The best answer is B. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation will not assign the exercise notice until the purchase of the option settles - and this occurs the next business day for a regular way options trade. Once the assignment occurs, the stock must be delivered to the holder of the call; or the stock must be delivered to the writer of the put; 2 business days after assignment.

All of the following investors are likely to trade foreign currency options EXCEPT: A. foreign corporations with multinational operations B. individuals with large U.S. dollar holdings C. individuals with large foreign currency holdings D. U.S. corporations with multinational operations

The best answer is B. Any multinational corporation will trade foreign currencies, either to acquire currency for payment in a particular country or to hedge transactions against fluctuations in currency values. Similarly, individuals with large foreign currency holdings are likely to use the foreign currency markets to hedge their positions. Individuals with U.S. dollar holdings have no need for the foreign currency markets - since they are not exposed to currency exchange risk.

In order to receive a dividend distribution, the last time for the holder of a call option to exercise is: A. at least 2 business days prior to the ex date B. just prior to the ex date C. just prior to the record date D. just after the ex date

The best answer is B. Exercise of an option results in a regular way trade. Stocks settle regular way 2 business days after trade date. Since the ex date is set at 1 business day prior to the record date, to receive the dividend, the stock must be bought 2 business days prior to the record date (or just prior to the ex date). Exercising the call just prior to the ex date is the same as buying the stock just prior to the ex date.

After exercising an equity options contract, the trade settles: A. next business day after trade date B. in 2 business days after trade date C. in 3 business days after trade date D. in 7 calendar days after trade date

The best answer is B. Exercise of an option results in a regular way trade. Stocks trades settle regular way 2 business days after trade date.

A customer buys 200 shares of ABC at $68 and sells 2 ABC Jan 70 Calls @ $3. The maximum potential gain is: A. $500 B. $1,000 C. $6,800 D. unlimited

The best answer is B. If the market rises, the calls are exercised. The stock (which cost $68) must be delivered at $70 for a gain of $2 per share. Since $3 was collected in premiums for selling each call, the net gain, if exercised, is 5 points or $500 per contract x 2 contracts = $1,000.

A customer buys 100 shares of ABC stock at $39 and sells 1 ABC Jan 45 Call @ $2 on the same day in a cash account. The customer's maximum potential loss is: A. $200 B. $3,700 C. $4,000 D. unlimited

The best answer is B. If the stock drops, the call expires "out the money." As the stock keeps dropping, the customer loses more and more on the stock position. Because she effectively paid $3,700 ($39 price - $2 premium collected) for the stock, this is her maximum potential loss.

Upon exercise of a British Pound World Currency call option, the writer will: A. receive U.S. Dollars B. deliver U.S. Dollars C. receive British Pounds D. deliver British Pounds

The best answer is B. If there is an exercise of a foreign currency option, settlement is the same as for exercise of index options. If a PHLX World Currency option is exercised, the writer must pay the holder the "in the money" amount the next business day. There is no delivery of the foreign currency upon exercise.

A customer wants to buy enough PHLX Canadian Dollar Feb 85 Put contracts to hedge a long 100,000 Canadian Dollar position. The customer must buy: A. 1 contract B. 10 contracts C. 100 contracts D. 1,000 contracts

The best answer is B. PHLX World Currency options cover 10,000 units of currency, with the exception of the Japanese Yen contract, which covers 1,000,000 units of currency. Since this customer is long 100,000 Canadian Dollars, and each put contract covers 10,000 Canadian Dollars, 10 contracts are needed to hedge the long foreign currency position from a market decline.

Which of the following positions has unlimited loss potential? I Short Naked Call II Short Stock / Long Call III Short Straddle IV Short Call / Long Stock A. I only B. I, III C. II, III D. I, II, III, IV

The best answer is B. Selling a naked call obligates the writer to deliver stock he does not own - thus there is unlimited risk. A short stock position is hedged by a long call - the long call allows the purchase of the stock at a fixed price, which can then be used to cover the short stock position. A short straddle involves the sale of a call and a put - both of which are naked. A naked call writer has unlimited risk. A long stock/short call position is a covered call writer - where the maximum loss would occur if the stock became worthless.

Which statement is TRUE regarding the VIX? A. It is the Value Line Index of 1700 stocks B. It is a bearish indicator when S&P 500 option premiums are increasing C. It is the broadest measure of the market D. It is a volatility index based on S&P 100 options contracts

The best answer is B. The VIX (Volatility Index Option) is based on the premium movements of S&P 500 Index options. As a general rule, options premiums will increase if the price movements of the underlying index or stock become more volatile. As S&P 500 Index options premiums increase, the VIX premium increases. Increasing volatility is a sign of investor fear, and is an indicator that stock prices are falling. Therefore, when S&P 500 options premiums are increasing (increasing VIX value), the market is becoming more volatile and stock prices are likely to be falling. Thus, the VIX option is negatively correlated to market price movements. Note that Choice D is "close" but the VIX is not based on the S&P 100 Index; rather it is based on the S&P 500 Index.

On the same day in a margin account, a customer buys 1 ABC Jan 55 Put @ $5 and sells 1 ABC Jan 70 Put @ $12 when the market price of ABC is $67. The maximum potential loss is: A. $700 B. $800 C. $1,000 D. $1,200

The best answer is B. The customer has created a short put spread resulting in a $700 credit. This position is profitable if the market should rise (bullish). The positions set up as: Sell 1 ABC Jan 70 Put @ $12 Buy 1 ABC Jan 55 Put @ $ 5 $ 7 Credit If the market should rise, both contracts expire "out the money" and the customer keeps the $700 credit (maximum potential gain). On the other hand, if the market drops, the short put is first to be exercised, requiring the customer to buy the stock at $70. If the market continues to fall, the long put allows the customer to sell the stock at $55, for a maximum loss on the stock of 15 points. Since 7 points were received in premiums, the maximum potential loss is $800.

Floor brokers on the Chicago Board Options Exchange: I can accept all orders II can only accept orders that are "away" from the market III can maintain bid and ask quotes IV cannot maintain bid and ask quotes A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The floor broker is an individual who executes transactions for retail member firms on the CBOE. The floor broker can trade with another floor broker, a Market Maker or an Order Book Official, earning a fee for each transaction. Floor brokers cannot maintain a bid-ask quote - they cannot be market makers. They can accept all orders, and are obligated to find the best available market. Regarding orders that are "away" from the market, that is, orders that cannot be executed immediately, these orders would be placed on the Order Book Official's book of open orders.

On the same day in a margin account, a customer buys 5 ABC January 40 Calls @ $6 and sells 10 ABC January 50 Calls @ $1 when the market price of ABC is at $43. The maximum potential profit is: A. $2,000 B. $3,000 C. $5,500 D. unlimited

The best answer is B. The maximum potential profit must occur at $50 per share. At this price, the customer would profit on the long call spreads, without losing anything on the 5 short calls - which would expire "at the money." At a $50 price, each long call spread results in a profit of 10 points (Buy the stock at $40 by exercising the long call and sell it at $50 in the market), net of $5 paid (net debit) in premiums per spread = $500 profit per spread x 5 spreads = $2,500 profit. The short naked 50 calls expire resulting in a $100 profit per contract ($1 credit) x 5 contracts = $500. The total profit is $2,500 + $500 = $3,000.

A foreign currency trader has bought 1,000,000 Canadian Dollars in the spot market at 91. To hedge, the trader buys 100 PHLX Jul Canadian Dollar 92 Puts @ 1.50. The position will breakeven at which price? A. .9050 B. .9250 C. .9350 D. .9450

The best answer is B. The trader bought the Canadian Dollars at 91 and paid a premium of 1.50 for the put option, for a total cost of .9250. To breakeven, the Canadian Dollar must rise to this level.

Trades of foreign currency options settle: I Cash II Spot III Forward IV Regular way A. I only B. I or IV C. II or III D. I, II, III, IV

The best answer is B. Trades of foreign currency options settle either cash (same day) or regular way (next business day). Do not confuse this with the settlement of trades of foreign currencies. Trades of foreign currencies settle either "spot" (1 or 2 business day settlement) or forward (a mutually agreed date in the future).

Which of the following is a settlement type for foreign currency option trading? A. Spot B. Regular Way C. Forward D. Future

The best answer is B. Trades of foreign currency options settle either cash (same day) or regular way (next business day). Do not confuse this with trades of foreign currencies. Trades of foreign currencies settle either "spot" (1 or 2 business day settlement - the more actively traded currencies settle in 1 day; less actively traded currencies settle in 2 days) or forward (a mutually agreed date in the future).

Exercise settlement of an index option contract occurs: A. the same day B. the next business day C. 2 business days after exercise date D. 5 business days after exercise date

The best answer is B. Unlike the exercise of a stock option, where a stock delivery must be made 2 business days after exercise date, index option exercises are settled in "cash." If an exercise occurs (which happens very rarely), the writer must pay the holder the "in the money" amount the next business day.

A customer buys 100 shares of XYZ at $74 and buys 1 XYZ Jan 75 Put @ $6. Just prior to expiration, the stock is trading at $72. The customer closes the option position at a premium of $2. One week later, the stock moves to $79 and the customer sells the stock position in the market. The net gain or loss on all transactions is: A. $100 loss B. $100 gain C. $200 gain D. $600 loss

The best answer is B. The put contract was purchased at $6 and closed (sold) at $2 for a net loss of $4. The stock was purchased at $74 and sold at $79 for a net gain of $5. The net of all transactions is a 1 point or $100 gain.f

On the same day when the market price of ABC stock is $59, a customer takes the following options positions: Buy 1 ABC Jan 55 Call @ $7 Sell 2 ABC Jan 60 Calls @ $4 Buy 1 ABC Jan 65 Call @ $2 This position is profitable when the market: A. moves sharply down B. moves sharply up C. is stable D. is volatile

The best answer is C. A butterfly spread is a market neutral position that is created by combining a "long" spread with a "short spread." It is called a "butterfly" because the 2 "outer" long positions are the wings of the butterfly, while the 2 short positions at the same strike are the "body" of the butterfly/ The position is established with a small debit that establishes the maximum potential loss if the market moves broadly up or down. If the market stays right in the middle ($60 in this example), the gain is maximized. Here is what happens as the market moves: Market is at $55 or lower: All positions expire and the net $1 debit is lost. Market moves to $56: $1 is gained on the long 55 call, offsetting the $1 debit = breakeven. Market moves to $57: $2 is gained on the long 55 call, offset by the $1 debit = $1 profit Market moves to $58: $3 is gained on the long 55 call, offset by the $1 debit = $2 profit Market moves to $59: $4 is gained on the long 55 call, offset by the $1 debit = $3 profit Market moves to $60: $5 is gained on the long 55 call, offset by the $1 debit = $4 profit. This is the maximum potential gain. Market moves to $61: $5 is gained on the exercise of the long 55 call and one of the short 60 calls, offset by a $1 loss on the other short 60 call and the $1 debit = $3 profit Market moves to $62: $5 is gained on the exercise of the long 55 call and one of the short 60 calls, offset by a $2 loss on the other short 60 call and the $1 debit = $2 profit Market moves to $63: $5 is gained on the exercise of the long 55 call and one of the short 60 calls, offset by a $3 loss on the other short 60 call and the $1 debit = $1 profit Market moves to $64: $5 is gained on the exercise of the long 55 call and one of the short 60 calls, offset by a $4 loss on the other short 60 call and the $1 debit = $0 profit. This is the upside breakeven. Market moves to $65 or higher: All positions are exercised. $5 is gained on the exercise of the long 55 call and one of the short 60 calls, offset by a $5 loss on the exercise other short 60 call and the long 65 call. The loss is the debit of $1.

To speculate on a falling interest rate environment, the strategy that would give the largest profit is to: A. Buy TYX calls B. Sell TYX calls C. Buy TYX puts D. Sell TYX puts

The best answer is C. Interest rate option premium movements are based on the movement of market interest rates. The TYX index option is based on the interest rate movement of the most recently auctioned 30-year Treasury Bond. To speculate on market interest rates falling, puts should be purchased. As market interest rates keep falling, the put premium keeps increasing. Note that selling a TYX call will also produce a profit in a falling interest rate environment because the call will expire "out the money" and the premium will be earned. But this strategy produces a fixed profit in a period of falling interest rates, while buying an interest rate put gives an ever-increasing profit as market interest rates fall.

Which statements are TRUE about LEAPs? I Contracts are available on individual equity securities II Contracts are available on indexes III Contracts for equity securities may be exercised at any time IV Contracts have maximum expirations of 9 months A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. LEAPs (Long term Equity AnticiPation options) are long term stock options that are traded on both individual stocks and stock indexes. Unlike regular individual stock options, which have maximum lives of about 9 months, or index options, which have a maximum life of 4 months, LEAPs are available in 28-month expirations for stocks; and 36-month expirations for index options. LEAPs allow investors to position themselves for market movements that are expected over a longer period of time. LEAPs are issued in the same style as the regular option contract for that underlying instrument. Since equity options and OEX options are American style, their LEAPs are American style as well (can be exercised at any time). In contrast, virtually all other index options, and therefore other index LEAPs, are European style. LEAPs are traded on the CBOE, alongside the regular stock options, and the OEX and SPX indexes. If LEAP equity contracts are exercised, the actual underlying security must be delivered, as is the case with a regular stock option. Each contract covers 100 shares. If LEAP contracts on indexes are exercised, the writer must pay the holder the "in the money" amount (identical to the exercise of regular index options). For LEAP index contracts, the multiplier is 100.

On the same day a customer buys 100 shares of ABC stock at $30 and sells 1 ABC Jan 30 Call @ $3 and sells 1 ABC Jan 30 Put @ $2. The maximum potential loss is: A. $500 B. $2,500 C. $5,500 D. Unlimited

The best answer is C. The customer has created a long stock/short straddle position. This is shown below: Buy 100 Shares of ABC at $30 Sell 1 ABC Jan 30 Call @ $3 Sell 1 ABC Jan 30 Put @ $2 $5 Credit The credit of $500 is the maximum potential gain occurring if both contracts expire "at the money." If the market rises above $30, the short call is exercised, while the short put expires "out the money." The stock that was purchased at $30 is delivered for $30 - there is no further gain or loss on this position. Thus, in a rising market, the maximum gain is $500. If the market falls below $30, the short put is exercised (requiring the customer to buy another 100 shares at $30), while the short call expires "out the money" As the market falls, the customer now owns 200 shares purchased at $30. Since $500 was collected in premiums, he can afford to lose 2.5 points per share and will still breakeven. Thus, the breakeven occurs at $30 - $2.50 = $27.50. If the market continues to drop to zero, the customer will lose the full value of the 200 shares purchased at $30, net of $500 collected in premiums, for a net loss of $5,500 ($27.50 per share).

Which of the following cover a short ABC put? I Long ABC stock position II Short ABC stock position III Cash equal to the aggregate exercise price A. I only B. II only C. II and III D. I, II, III

The best answer is C. A long stock position is not considered "cover" for a short put since as the market goes down, the short put is exercised and there is increasing loss on the stock position. The O.C.C. accepts as "cover" a long put with the same strike price or higher (thus creating a long put spread), a bank guarantee letter (where the bank assumes responsibility for loss), or an escrow receipt for cash sufficient to pay for the stock should the put be exercised. A short stock position also covers a short put, since the credit from the sale of the stock is available to "pay" for the purchase of the stock should the short put be exercised.

Regular way trades of which of the following securities settle next business day? I Listed stocks II Listed stock options III U.S. Government bonds A. I only B. II only C. II and III only D. I, II, III

The best answer is C. Regular way trades of both listed options and U.S. Government securities settle next business day. Regular way trades of stocks and corporate and municipal bonds settle 2 business days after trade date.

A customer buys 100 shares of XYZ stock at $80 and buys 1 XYZ Oct 80 Put @ $3 on the same day in a cash account. The stock rises to $88. The put expires and the customer sells the stock in the market at the current price. The customer has a(n): A. $300 loss B. $300 gain C. $500 gain D. $800 gain

The best answer is C. The customer buys the put for $3 and buys the stock at $80 for a total outlay of $83 per share. The put has been purchased as protection if the stock price should fall. In this case, the stock price rises to $88, so the customer lets the put expire "out the money" and sells the stock in the market at the current price. The net gain is $88 - $83 = $5 or $500 on 100 shares.

On the same day in a margin account, a customer purchases 1 MNO Jan 50 Call @ $9 and sells 1 MNO Jan 60 Call @ $2. The customer will profit if: I the spread between the premiums narrows II the spread between the premiums widens III both contracts are exercised IV both contracts expire A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. This is a debit price spread. Debit spreads are profitable if the spread between the premiums widens. At this point, the positions can be closed out at a larger credit. If both positions are exercised, the customer buys the stock at $50 through the long call and delivers it at $60 on the short call for a 10 point gain. Since $7 was paid in premiums, the net gain is $3 or $300. If both positions expire, the customer loses the $7 debit. If the spread narrows below $7, the credit upon closeout will not be enough to cover the $7 debit paid and a loss is incurred.

Which statements are TRUE? I Trades of foreign currencies take place on the Philadelphia Stock Exchange II Trades of foreign currency options take place on the Philadelphia Stock Exchange III Trades of foreign currencies take place in the interbank market IV Trades of foreign currency options take place in the interbank market A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Trading of foreign currency options in the United States takes place on the Philadelphia Stock Exchange. The trading of foreign currencies takes place over-the-counter in the "interbank" market.

A customer who is short stock will buy a call to: A. hedge the short stock position in a falling market B. protect the short stock position from a falling market C. protect the short stock position from a rising market D. generate additional income in a stable market

The best answer is C. A customer who has shorted stock is bearish on the market. However, the potential loss for a short seller of stock is unlimited if the market should rise, forcing the customer to replace the borrowed shares at a much higher price. To limit this risk, the purchase of a call allows the stock position to be bought at a fixed price (by exercising the call), if needed, in a rising market.

A customer buys 100 shares of ABC stock at $66 and buys 1 ABC Oct 65 Put @ $3. ABC stock falls to $58 and just prior to expiration, the customer exercises the put, delivering the stock position. The customer has a: A. $200 loss B. $300 loss C. $400 loss D. $700 loss

The best answer is C. The customer bought the stock at $66 and sold at $65 by exercising the put. There is a 1 point loss on the stock position. Also, the customer lost the $300 premium paid, so the customer loses a total of $400.

A customer sells short 100 shares of PDQ at $58 and buys 1 PDQ Jul 60 Call @ $3. The customer's maximum potential loss is: A. $200 B. $300 C. $500 D. unlimited

The best answer is C. The long call allows the customer to buy in the stock position at $60. Since the stock was sold at $58, exercise results in a net loss of $2 on the stock. The customer paid $3 for the call, so the total loss is $500.

The January stock option contracts of a company assigned to Cycle 3 have just expired. Which contracts will commence trading on the CBOE? A. February B. March C. July D. September

The best answer is D. The options cycles are: Cycle 1 Jan Apr Jul Oct Cycle 2 Feb May Aug Nov Cycle 3 Mar Jun Sep Dec Cycle 3 contracts are issued for the months of Mar - Jun - Sept - Dec. One can always get a contract for this month, next month, and the next 2 months in the Cycle. In January, prior to expiration, the contracts that will trade are January (this month), February (next month), March and June (the next 2 months in the cycle). After January contracts expire, the contracts that will trade are February (this month), March (next month), June and September (the next 2 months in the cycle).

A mutual fund manager of a country fund wishes to hedge the portfolio against a market decline. The best strategy is to buy: A. broad-based calls B. broad-based puts C. narrow-based calls D. narrow-based puts

The best answer is D. A "country" fund is composed of the stocks of companies located in a single country, such as the Japan Fund; or the Mexico Fund. The volatility of such funds differs from the volatility of the market as a whole. The best way to hedge is with index puts, such as the Japan index option; or the Mexico index option. These are narrow based contracts.

A customer who is long 1 ABC Jan 75 Call wishes to create a "bull call spread." The second option position that the customer must take is: A. Short 1 ABC Jan 65 Put B. Short 1 ABC Jan 85 Put C. Short 1 ABC Jan 65 Call D. Short 1 ABC Jan 85 Call

The best answer is D. A spread consists of the purchase and sale of the same type of option (calls in this case) with different strike prices and/or expirations. In a bull call spread, the customer hopes that the market will rise, but does not believe that the market will rise by a large amount. If a customer is long an ABC Jan 75 Call, he will gain if the market rises above $75. If the customer believes that the market will not go above $85, he or she can sell an ABC Jan 85 Call. The premium collected on the sale of the 85 call reduces the cost of the 75 call. However, the reduced cost also reduces the potential gain for this customer. If the market rises sharply, the customer can only make 10 points on the positions. This occurs because both calls would be exercised, and the stock that is purchased at $75, would be delivered at $85, for a 10 point gain

A customer who is short 1 ABC Jan 70 Put wishes to create a "credit put spread." The second option position that the customer must take is: A. Long 1 ABC 85 Call B. Long 1 ABC 60 Call C. Long 1 ABC 85 Put D. Long 1 ABC 60 Put

The best answer is D. A spread consists of the purchase and sale of the same type of option with a different strike price and/or expiration - therefore Choices A and B are incorrect. In a bull put spread (the same as a short put spread), the customer purchases the lower strike price (lower premium since the contract allows the holder to sell at a lower price) and sells the one with the higher strike (higher premium, since the contract allows the holder to sell at a higher price). The spread results in a credit received, which the customer wants to keep. If the market rises, then the contracts expire "out the money" and the net premium received is kept. This is the maximum gain. If the market falls, in this case below $60, then both contracts are exercised at a loss to the customer. If the market falls below $60, then the customer is obligated to buy stock at $70; that he sells at $60; for a 10 point loss (net of any premium credit received). This is the maximum potential loss.

A customer who is long 1 ABC Jan 30 Call wishes to create a "long call spread." The second option position that the customer must take is: A. long 1 ABC Jan 20 Call B. long 1 ABC Jan 40 Call C. short 1 ABC Jan 20 Call D. short 1 ABC Jan 40 Call

The best answer is D. A spread is a buy and a sell of the same type of option. Since the customer is already long a call, he or she must be short a call to create a spread. In order for the position to be a "long call spread," the customer must be a net buyer, meaning he or she must purchase the more expensive contract and sell the less expensive one. Since the lower strike price contracts are worth more money (for calls, since it is more advantageous to buy cheaper), he must sell the higher strike price contract to be a net buyer of the position. In this case, since the customer is already long a Jan 30 Call, to create a spread, a higher strike price call must be sold - and the only choice given that meets this criteria is to sell a Jan 40 Call. This is a moderately bullish strategy.

All of the following statements are true about the CBOE Order Support System (OSS) EXCEPT: A. the order is routed directly to the market maker or order book official for execution B. execution notices are sent directly from the trading post to the brokerage firm C. the system is faster and cheaper to use than manual trading D. the customer must request the use of the system when placing an options order

The best answer is D. All automated trading systems function in a similar fashion. Orders are routed directly to the trading post, eliminating the need for the order to be wired to the communication post on the exchange floor and then written by hand to be given to a floor broker. The execution report is sent directly to the originating firm; it does not go through the firm's communication post. Such systems are cheaper and faster than manual trading. The majority of trades are now handled in this fashion - the use of the system is transparent to the customer.

Which of the following statements are TRUE regarding the exercise of foreign currency option contracts? I The contracts settle in the foreign currency II The contracts settle in U.S. dollars III The contracts are available in American style IV The contracts are available in European style A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Exercise settlement of foreign currency options requires the writer to pay the holder the "in the money" amount in U.S. Dollars the next business day. Only European style contracts are available for PHLX World Currency options. Remember, American style contracts can be exercised at any time up until expiration, while European contracts can only be exercised just prior to expiration. Only one contract size (10,000 units of currency except for Japanese Yen which covers 1,000,000 units of currency) is available for each foreign currency on the PHLX.

All of the following statements regarding exercise of index options are true EXCEPT: A. upon exercise, settlement occurs next business day B. upon exercise, the seller must pay the buyer the "in the money" amount. C. the "in the money" amount is based upon the closing index value on the day of exercise D. the maximum risk for the writer of the index contract is the loss of the premium

The best answer is D. If an index option is exercised, the writer must pay the holder the "in the money" amount the next business day. There is no delivery of the stocks that are in the index - these are termed "cash settled options." The index value is computed as of the close the day of exercise. The writer of an index call has unlimited risk; the writer of an index put has increasing risk as the market drops.

If the market price of the underlying security remains the same as the strike price of the option contract, which of the following will have a profit? I The buyer of an "at the money" straddle II The seller of an "at the money" straddle III The seller of an "at the money" call A. I only B. II only C. III only D. II and III

The best answer is D. If the market price remains the same as the strike price, then there is no reason for the holder of an option contract to exercise. The contracts will expire and the holder will lose the premium, while the writer will gain the premium. Sellers of contracts and straddles (the sale of a call and a put on the same stock with the same strike price and expiration) will profit. Holders of contracts and straddles will lose the premiums paid.

A customer buys 100 shares of ABC stock at $39 and sells 1 ABC Jan 45 Call @ $2 on the same day in a cash account. The customer's maximum potential gain until the option expires is: A. $200 B. $300 C. $700 D. $800

The best answer is D. If the market rises above $45 the short call will be exercised. The customer must deliver the stock that he bought at $39 for the $45 strike price, resulting in a $600 gain. Since $200 was collected in premiums as well, the total gain is $800. This is the maximum potential gain while both positions are in place.

A customer buys an ABC May 50 Put and sells an ABC Jun 50 Put. The customer profits if: I The spread widens II The spread narrows III Both contracts expire A. I only B. II only C. I and III D. II and III

The best answer is D. The June expiration must be longer than the May expiration. The maximum life of a regular option contract is 9 months. If it is now May, then the June contract can trade (since it is 1 month later than May). However, if it is June, a May contract cannot be trading, because the following May is 11 months away. Thus, the customer is buying the near expiration (less expensive) and selling the far expiration (more expensive since there is more time left to the contract), so this must be a credit calendar spread. Credit spreads are profitable if the spread between the premiums narrows. If both contracts expire, the credit is the profit. If both contracts are exercised, the customer buys the stock at 50 and sells it at 50, still keeping the credit.

On the same day in a margin account, a customer buys 1 ABC Jan 50 Put @ $5 and sells 1 ABC Jan 40 Put @ $2. Below which of the following prices will every dollar gained on the long put be exactly offset by a dollar lost on the short put? A. $50 B. $47 C. $42 D. $40

The best answer is D. The breakeven point is $47 per share. As the market falls below $47, the customer gains 1 point on the long 50 put for every $1 fall in the price of ABC stock. Once the market goes below $40, the short put will be "in the money," and a dollar will be lost on the short put for every dollar gained on the long put. Thus, below $40, there is no further gain. The maximum gain potential is 7 points or $700.

On the same day, a customer sells 1 ABC Jan 50 Call @ $5 and buys 1 ABC Jan 60 Call @ $2. Above which of the following prices will every dollar lost on the short call be exactly offset by a dollar gained on the long call? A. $50 B. $53 C. $58 D. $60

The best answer is D. The breakeven point is $53 per share. As the market rises above $53, the customer loses 1 point on the short 50 call for every $1 rise in the price of ABC stock. Once the market goes above $60, the long call will be "in the money," and a dollar will be gained on the long call for every dollar lost on the short call. Thus, above $60, there is no further loss. The maximum loss potential is 7 points or $700.

A customer buys 100,000 Canadian Dollars at 91 and buys 10 PHLX Canadian Dollar Oct 90 Puts @ 2.50. The customer profits if the Canadian Dollar is trading: A. below $.8750 B. below $.8850 C. above $.9250 D. above $.9350

The best answer is D. The customer bought the Canadian Dollars at $.91 and bought a put at a premium of $.025 as a hedge against a fall in the currency. The total outlay was $.91 + $.025 = $.9350 per Canadian Dollar. To profit, the Canadian Dollar must rise above $.9350.

A customer writes 1 XYZ Jan 40 Put. To cover the position, the customer would: A. Buy 1 XYZ Dec 30 Put B. Buy 1 XYZ Feb 30 Put C. Buy 1 XYZ Dec 50 Put D. Buy 1 XYZ Feb 50 Put

The best answer is D. The customer has sold 1 XYZ Jan 40 Put. Thus, if the customer is exercised, he or she is obligated to buy XYZ stock at $40 per share. If the customer buys 1 XYZ Jan 50 Put, then the customer can always exercise the long put and sell that stock for $50, if it is put to him for $40. By purchasing the 50 put, the customer has created a "long put spread." Purchasing the XYZ Jan 30 Put does not cover the customer under O.C.C. rules. If the customer is exercised on the short put, buying the stock for $40, by exercising the long 30 put, he can only sell at $30 per share, losing 10 points in the process. To be covered under O.C.C. rules, the strike price of the long put must be the same or higher than that of the short put. Furthermore, the expiration on the long put must be the same, or longer than the short put. If the customer buys a Dec 50 Put and the short Jan 40 Put is exercised in January, then the December put expired and the writer is "naked." If the customer buys a Feb 50 Put and the short Jan 40 Put is exercised in January obligating the customer to buy the stock at $40, then the customer simply exercises the Feb 50 Put and puts the stock to someone else at $50, for a $10 point profit.

A customer sells 1 XMI Dec 530 Put @ $8 when the index is at 529.00. The customer is exercised when the index closes at 525.00. The writer must pay: A. $30,000 to the holder B. $5,000 to the holder C. $1,000 to the holder D. $500 to the holder

The best answer is D. The put has a strike price of 530. Upon exercise, the index closes at 525, therefore the put is "in the money" by 5 points or $500. The writer must pay this amount to the holder.

A customer places an order to buy 1 ABC Jan 60 Call and buy 1 ABC Jan 60 Put, at a maximum debit of $8. This order should be: A. rejected because it is uneconomic B. written on 2 separate order tickets, 1 for the buy order; and another for the sell order C. written on 1 ticket and market as a spread D. written on 1 ticket and marked as a straddle

The best answer is D. This customer is specifying that a straddle be purchased at a net debit not to exceed $8. The successful execution of this order requires that both "legs" of the straddle be executed at the same time within the customer's limit (the debit). To facilitate the handling of such "one-on-one" orders (the same is also true for spread and combination orders), the CBOE has the "spread priority rule." This rule states that a spread, straddle or combination order has priority over equivalent single sided orders on the trading floor. In this manner, it is easier for traders to successfully execute spread, straddle and combination orders.

A customer sells 1 ABC Jan 40 Call @ 8 and buys 1 ABC Jan 55 Call @ 2 when the market price of ABC is 43. The customer will profit or breakeven at all of the following prices EXCEPT: A. 40 B. 44 C. 46 D. 50

The best answer is D. When the market price is at 40, both contracts will expire and the customer will receive a net credit of 6 points. When the market is at 44, the 40 call will be exercised, forcing the customer to buy stock at the market (44) and to deliver at 40 for a loss on the stock position of 4, but he still has a net credit from the option contracts of 6. So the customer still has a gain of: 6 - 4 = 2 point gain. When the market is at 46, the customer must deliver at 40 (once again, the 40 call is exercised). He or she has to go to the market to get the stock at 46. This is breakeven since he loses 6 points on the stock position, but he had a net credit from the premiums of 6. The customer starts to lose at any dollar price above $46. To summarize, the breakeven formula for a short call spread is:

Canadian Dollar Feb 80 Calls on the PHLX are quoted at 1.25. Canadian Dollars are trading at 80.25. The contract size is 10,000 dollars (Canadian). What is the total premium for 10 contracts? A. $1.25 B. $12.50 C. $125.00 D. $1,250.00

The best answer is D. World Currency options are standardized, using a multiplier of 100 applied to the premium. A premium of 1.25 x multiplier of 100 = $125 total premium per contract. Since 10 contracts are purchased, 125 x 10 contracts = $1,250 total premium. (Another way of doing this - but not necessarily recommended - is contract size = 10,000 units of currency x a premium of 1.25 cents ($.0125) = $125 per contract x 10 contracts = $1,250.)

On the same day a customer sells 1 ABC Jan 50 Call @ $2 and buys 1 ABC Jan 35 Call @ $8 when the market price of ABC is $41 The maximum potential loss is: A. $600 B. $800 C. $900 D. unlimited

The best answer is A. The customer has purchased a long call spread. The positions are: Buy 1 ABC Jan 35 Call @ $8 Sell 1 ABC Jan 50 Call @ $2 $6 Debit If the market falls below $35, both calls expire "out the money" and the customer loses the net 6 points paid in premiums.

A customer buys 1 OEX Jan 530 Call @ $3. The overall market rises and the index closes at 533.27, while OEX 530 Call contracts close at $6.50. Which is the most profitable action? A. Close the position B. Exercise the position C. Let the position expire D. Roll-up the position

The best answer is A. If the position is closed, the customer makes 3.50 points (Bought at $3; Sold at $6.50) = $350. If the position were exercised, the writer must pay the holder the "in the money" amount. This is a 530 Call when the index value is at 533.27 = 3.27 "in the money" times a multiplier of 100 = $327 to be paid from writer to holder. Since a $300 premium was paid by the holder, the net profit is $27 resulting from the exercise. If the position expires, the holder loses the $300 premium paid. The last choice, "rolling-up the position" is an advanced strategy that is not tested.

A customer buys 1 PHLX Canadian Dollar Jan 98 Call @ 2 and 1 PHLX Canadian Dollar Jan 98 Put @ 3 when the Canadian Dollar is trading at $.9875. The contract size is 10,000 Canadian Dollars. The breakeven points are: A. $.93 and $1.03 B. $.95 and $1.00 C. $.96 and $.91 D. $1.01 and $1.03

The best answer is A. To breakeven on a long straddle, the total premium must be recovered, either moving up on the call or down on the put. To recover 5 cents total premium paid on the call, the market price must move to 98 + 5 = 103 = $1.03. To recover 5 cents on the put, the market price must move down to 98 - 5 = 93 = $.93.

The Major Market Index Option contract is traded on the: A. New York Stock Exchange B. American Stock Exchange C. Chicago Board Options Exchange D. Chicago Mercantile Exchange

The best answer is B. The Major Market Index Option contract (XMI) is traded on the American Stock Exchange.

Which of the following positions creates a Long Straddle? A. Long 1 ABC Jan 50 Call; Long 1 ABC Apr 50 Put B. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put C. Long 1 ABC Jan 50 Put; Long 1 ABC Jan 50 Call D. Short 1 ABC Jan 50 Put; Short 1 ABC Jan 50 Call

The best answer is C. A long straddle is the purchase of a call and the purchase of a put, with the same strike price and expiration. Note that in Choices A and B, either the strike price and/or expiration are different.

(Refer to the exhibit window to answer the following question) A customer owns an ABC Call option. ABC declares a dividend for shareholders on record July 17th. The last day to exercise the option and get the dividend is: A. July 11th B. July 12th C. July 15th D. July 16th

The best answer is C. If an option is exercised, a regular way stock trade results (2 business day settlement). To be an owner of record, the call must be exercised 2 business days prior to July 17th, which is July 15th. Notice that to get the dividend, the call must be exercised just prior to the ex date (which is the business day before the record date, so in the case the ex date is July 16th).

A customer buys 1 ABC Jan 40 Put @ $1 and sells 1 ABC Jan 55 Put @ $7 when the market price of ABC is $57. The position will be profitable if: I both contracts are exercised II both contracts expire III the spread narrows IV the spread widens A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. If the market drops, both puts are exercised and the customer loses $900 (buy stock at $55; sell at $40; for a 15 point loss, net of $6 credit received). If the market rises above $55, both puts expire and the customer earns the $600 credit. Since this is a credit spread, it must be closed at a debit. To be profitable, the closing debit must be smaller, so the spread must narrow.

A customer buys 1 ABC Jan 55 Call @ $11 and 1 ABC Jan 55 Put @ $3 when the market price of ABC is at $61. If ABC stock moves to $64 and stays there, the gain or loss at expiration is: A. $300 loss B. $500 gain C. $500 loss D. $1,100 gain

The best answer is C. If the stock moves to $64, the call goes "in the money" and will be exercised and the put expires "out the money." When the call is exercised, the customer buys the stock at the strike price of $55, and sells it at the current market price of $64, for a 9 point gain. However, since 14 points was paid in combined premiums, the net result is a loss of 5 points or $500.

The Standard and Poor's 100 Index has closed at 572.12, up 1 point from the prior day's close. The holder of 1 "deep in the money" OEX Call contract would have an approximate gain of: A. $1 B. $10 C. $100 D. $1,000

The best answer is C. Index option contracts have a multiplier of 100. A change of 1 equals 100 x 1 = $100.00 per contract. Since this person holds 1 contract, the change in value is 1 x $100 = $100.

All of the following statements are true regarding the Order Book Official EXCEPT the OBO: A. is an exchange employee B. runs the book of public orders C. makes a market in options contracts D. does not maintain an options inventory

The best answer is C. The Order Book Official is an employee of the Chicago Board Options Exchange who runs the book of public orders. The "OBO" does not make a market in the option contracts and does not maintain inventory - this function is performed by the "MM" - Market Maker. The "OBO" performs the book function for option contracts.

The Standard and Poor's 100 Index Option contract is traded on the: A. New York Stock Exchange B. American Stock Exchange C. Chicago Board Options Exchange D. Chicago Mercantile Exchange

The best answer is C. The Standard and Poor's 100 option contract (OEX) trades on the Chicago Board Options Exchange.

Cabinet trades effected on the CBOE: I can be used by customers to close out worthless long positions II can be used by customers to close out worthless short positions III result in an aggregate $1 premium per contract as a result of the transaction IV result in an aggregate $1 commission per contract as a result of the transaction A. I and IV B. II and III C. I, II, III D. I, II, III, IV

Cabinet trades effected on the CBOE: I can be used by customers to close out worthless long positions II can be used by customers to close out worthless short positions III result in an aggregate $1 premium per contract as a result of the transaction IV result in an aggregate $1 commission per contract as a result of the transaction A. I and IV B. II and III C. I, II, III D. I, II, III, IV

Which of the following statements are TRUE about the CBOE Order Support System? I Orders are directed to the brokerage firm's communication post on the exchange floor II Orders are routed directly to the trading post, bypassing the firm's communication post III Execution notices are sent to the brokerage firm's communication post on the exchange floor IV Execution notices are sent directly from the trading post to the brokerage firm A. I and III B. I and IV C. II and III D. II and IV

Which of the following statements are TRUE about the CBOE Order Support System? I Orders are directed to the brokerage firm's communication post on the exchange floor II Orders are routed directly to the trading post, bypassing the firm's communication post III Execution notices are sent to the brokerage firm's communication post on the exchange floor IV Execution notices are sent directly from the trading post to the brokerage firm A. I and III B. I and IV C. II and III D. II and IV