Progress Exam 5A & 5B
Which of the following long option positions is a straddle? Long an October 50 put and long an October 50 call Long an October 40 put and long an October 50 call Long an October 50 put and long a January 50 call Long an October 40 put and long a January 50 call
A A long straddle is the purchase of a put and a call on the same underlying security with the same exercise price and the same expiration date. Of the choices given, the long October 50 put and October 50 call (the strike price and expiration date are the same) is a straddle.
Which of the following statements is TRUE in relation to the buyer of a call option? The investor has limited risk The investor has a limited potential profit The investor is entitled to all dividends paid on the underlying stock The investor must exercise the option if the underlying stock goes up
A A purchaser of a call option would have limited risk with the potential for unlimited profit. The risk is the possibility of losing the entire premium (cost of the option). The owner of the call option is not an equity owner of the stock unless and until the option is exercised.
Which of the following statements is TRUE regarding spreads? A put spread created for a net debit is bearish A put spread created for a net credit is bearish A call spread created for a net credit is bullish A call spread created for a net debit is bearish
A A put spread created for a net debit is bearish. A bearish put (or call) spread involves selling the lower exercise price and buying the higher exercise price. For a put spread, the lower exercise price will have the lower premium and, therefore, the spread will be done at a debit. The following table summarizes call and put spreads created at debits and credits. Debit call spread Bull Spread Credit call spread Bear Spread Debit put spread Bear Spread Credit put spread Bull Spread
An investor bought 5 ATT June 30 puts. These options will have intrinsic value when the market price of ATT is: $25 $30 $35 $40
A A put will have intrinsic value (also known as being in-the-money) when the market price of the underlying security is less than the strike price. Of the choices given, the only one which is lower than the exercise price is $25.
An individual purchases one ABC 35 put for 2.50 and one ABC 30 put for .75. The market price of ABC stock is currently 34. The individual's breakeven price is: 32.50 31.75 29.25 26.75
A Buying two puts with different strike prices is a bearish strategy. In this example, since one of the strike prices is lower, it is less expensive than buying two puts with the same strike price. The total cost of the ABC puts is 3.25. The 35 put would be exercised first, resulting in total proceeds of 31.75 (35.00 - 3.25). This is what the individual would pay to purchase ABC and still break even. If the market price of the stock is trading at any other value, the client would either have a profit or loss. For example, if the market price at expiration is $26.75, the client will have an $825 gain on the 35 put (35 - 26.75) and a $325 gain on the 30 put (30 - 26.75). The total gain of $1,150 less the combined $325 premium equals an $825 profit.
A client who buys 10 WR July 60 calls and sells 10 WR July 70 calls will profit if the price of the underlying security: Rises Falls Is volatile Stays neutral
A By buying and selling call options with the same expiration month and different exercise prices, the client is creating a vertical (price) spread. Since the call option being purchased has a lower strike price, and the right to purchase (call) a security at a lower price is more valuable, this option will have a higher premium. This is a call debit spread and the client will profit if the underlying security rises (bullish).
A client buys 5 EW April 75 puts and sells 5 EW April 80 puts. This type of strategy is: Bullish Bearish Volatile Neutral
A By buying and selling put options with the same expiration month and different exercise prices, the client is creating a vertical (price) spread. Since the put option being sold has a higher strike price, and the right to sell a security (put) at a higher price is more valuable, this option will have a higher premium. This is a put credit spread and the client will profit if the underlying security rises (bullish).
A customer wishes to close out a long option position by liquidating the option. The registered representative should mark the order ticket: Closing sale Closing purchase Opening purchase Opening sale
A The client initially created an opening purchase transaction when buying the option. To liquidate the long option position, the client must sell the option contract. The registered representative should, therefore, mark the order ticket closing sale.
A client purchases a July 50 Put @ 6 and writes a July 70 Put @ 13, creating a spread position. The client will profit if: The spread narrows The spread widens Both (a) and (b) Neither (a) nor (b)
A The client received more for the contract he sold than he paid for the contract he purchased (received a premium of 13 and paid a premium of 6). This is a credit spread. A client with a credit spread will profit if the spread narrows. The term spread refers to the difference between the premiums for each option.
In May, a customer sells an ABC July 40 listed call for a $6 premium and buys an ABC October 40 listed call for a $10 premium. In June, the customer closes out the July 40 sale for which he received a $6 premium by buying back the call at $9. He sells the October 40 call, which he purchased at $10, for $12. The net result to the customer on the two transactions is a: $100 loss $100 profit $200 loss $200 profit
A The customer lost $300 on the repurchase of the July 40 call. This was partially offset by the $200 profit on the sale of the October 40 call. The net result to the customer on the two transactions is a $100 loss.
A customer purchases an ABC October 60 call paying a $4 premium and an ABC October 60 put for a $4 premium. ABC goes up to $75 per share. The put option expires unexercised. The customer exercises the call option and simultaneously sells the stock at the market price of $75. As a result of the transaction, the customer has a net: $700 profit $700 loss $800 profit $800 loss
A The customer paid $800 in premiums ($400 for the call and $400 for the put). If the call is exercised at the $60 strike price and the stock is simultaneously sold for $75, the owner of the call would realize a $1,500 profit ($7,500 market price - $6,000 strike price = $1,500 profit). After deducting the $800 paid in premiums from the $1,500 profit, the customer has a net $700 profit.
A customer sells an NJF 20 straddle and receives a premium of $800. The put side of the straddle expires unexercised but the call is exercised. The customer is uncovered on the call and must purchase the stock in the market to effect delivery to the buyer of the call. The current market price of NJF Corporation is $29. The net result to the customer will be a: $100 loss $100 profit $2,100 profit $2,100 loss
A The customer received $800 from the sale of the straddle. The customer is required to buy 100 shares of NJF Corporation at the current market price of $29 for $2,900. She delivers the stock to the option buyer for the call price of $20, receiving $2,000. The customer sustains a $900 loss from the exercise of the uncovered call option position, but receives $800 from the sale of the straddle, resulting in a net loss of $100.
An investor established the following positions. Long 100 shares of XYZ at $22 per share Long 1 XYZ 20 put for .75 This investor most prefers XYZ to: Appreciate significantly Depreciate significantly Fluctuate Not change
A The investor purchased the stock at $22 per share and protected it from depreciating by purchasing the right to sell XYZ at $20 for a premium of .75 (long XYZ 20 put). The investor will lose money if the stock falls below a breakeven price of $22.75 ($22 purchase price of the stock + the .75 premium on the put). Therefore, the investor prefers XYZ to appreciate significantly as there is the potential for unlimited gains.
An investor writes an uncovered RST May 25 put for a premium of 4. The maximum profit the investor can realize is: $400 $2,100 $2,500 An unlimited amount
A The writer received the $400 premium. If the option expires, he will have no obligation, thereby recognizing the entire premium as profit. The premium represents the most that the writer can profit.
What is a client's maximum gain if she is long XAM stock and short an XAM call? The difference between the market price and the strike price plus the premium The difference between the market price and the strike price minus the premium The market price minus the premium Unlimited
A This is an example of a covered call (long stock + short call). The client's maximum gain is the difference between the market price and the strike price plus the premium. For example, if a client buys stock at $34 a share and writes a $40 call for a premium of 2, the maximum profit is $8. If the stock price rises above the option's strike price, the call will be exercised. The investor still retains the premium plus the difference from selling the stock at its strike price, but that is the client's maximum gain.
In June, a client buys 100 shares of XYZ Corporation at $27 per share and writes an XYZ October 30 call at a $3 premium. The trade is executed in a cash account. What is the breakeven point for the writer? $24 $27 $30 $33
A To find the breakeven point for the covered call writer, subtract the premium from the cost of the stock. The cost of the stock ($27) minus the premium ($3 per share), equals a breakeven point of $24.
An investor purchases 1 XYZ October 40 put when the market price of XYZ is $41 per share, and pays a premium of $3. If XYZ declines to $35 and the investor exercises the put, disregarding commissions, what is the profit or loss to the investor? $200 profit $200 loss $300 profit $600 profit
A When XYZ declines to $35 per share, the investor exercises the put, buys 100 shares in the market, and then sells (puts) them to the writer at the $40 strike price. The proceeds of the sale equal $3,700 ($4,000 strike price received minus $300 premium paid). Subtracting the cost of $3,500 to acquire the shares results in a profit of $200.
An investor writes an XYZ October 70 call at 3 and an XYZ October 70 put at 1. This strategy is known as a: Short combination Short straddle Bull spread Bear spread
B A long straddle consists of purchasing a put and a call, on the same underlying security, with the same strike price and same expiration. A short straddle consists of selling a put and a call, on the same underlying security, with the same strike price and expiration.
Which TWO of the following option tranactions combined will create a debit call spread? Buy 1 ATT June 30 Call at 5 Write 1 ATT June 30 Call at 5 Buy 1 ATT June 35 Call at 1 Write 1 ATT June 35 Call at 1 I and III I and IV II and III II and IV
B A spread involves the simultaneous purchase and sale of the same class of options with different series. If a customer buys the ATT June 30 call for 5 and writes the ATT June 35 call at 1, he will have created a debit call spread.
In which TWO of the following circumstances does an investor have unlimited risk? Short 1 XYZ July 50 put Short 100 shares of XYZ stock Short 1 XYZ July 50 uncovered call Short 1 XYZ July 50 covered call I and II II and III I and III II and IV
B An investor risks unlimited loss when short stock and when shorting an uncovered call. If an individual is short stock or short an uncovered call, there is no limit to how high the price of the stock can rise. In the case of the short stock position and the short call position, the investor will be required to buy the stock in the market at the prevailing price. The loss is theoretically unlimited.
An investor will be in a position to acquire stock under which TWO of the following circumstances? The investor buys a call The investor buys a put The investor sells a call The investor sells a put I and III I and IV II and III II and IV
B An investor who buys a call and exercises the call will acquire 100 shares of stock. An investor who sells a put that is exercised against him will also acquire 100 shares of stock.
Which of the following statements is NOT TRUE regarding the writer of a call option? The writer has an obligation to sell stock if exercised The writer profits if he closes the position after the premium increases The writer has an unlimited loss if the call option is not covered The writer benefits if the underlying stock declines
B Choice (b) is not true. The writer profits if he closes the position and buys the option back at a lower premium. The other choices are true statements. The writer has an obligation to sell stock if exercised, has an unlimited loss if not covered, and benefits if the underlying stock declines in value.
If an investor purchases one XYZ October 40 put for $500 when XYZ is selling at $38, the intrinsic value of the option is: $0 $200 $300 $500
B The put is 2 points in-the-money and this is its intrinsic value. Time value is 3 points. Since the contract size is 100 shares, the intrinsic value equals $200 and the time value equals $300.
Mr. Jones purchases 100 shares of IBM at $116 per share and writes an IBM June 115 call option at 5. Mr. Jones' breakeven point is: 110 111 120 121
B The writer of a covered call will have a breakeven point equal to the purchase price of the stock (116) less the premium received (5). Therefore, his breakeven point is $111 ($116 - $5 = $111).
A customer writes an IBM October 120 call, receiving a $4 premium, and buys an IBM October 100 call, paying a $12 premium. IBM is currently selling at $108. If he exercises the IBM October 100 call just prior to expiration, what should the stock be selling at in order for the customer to break even? 100 108 116 120
B IBM should be selling at $108 at expiration for the customer to break even. The customer will call away the stock at the $100 strike price, but receive stock worth $108, for an $8 profit. However, to create the spread, it cost the customer $8 ($12 to buy the October 100 call minus the $4 he received on the sale of the October 120 call). Therefore, when the stock is at $108, the customer will break even. The profit on exercising the option is offset by the cost of creating the spread position.
An individual expects the market price of XYZ to increase. Which TWO of the following choices support his market sentiment? Buy XYZ call options Write uncovered XYZ call options Buy XYZ put options Write uncovered XYZ put options I and III I and IV II and III II and IV
B Since the individual is bullish, he should buy calls and/or write puts on the underlying stock. A bearish investor should buy puts or write calls.
If an individual expects the market price of Xerox to go up, which TWO of the following strategies would be appropriate? Buy Xerox call options Write uncovered Xerox call options Buy Xerox put options Write uncovered Xerox put options I and III I and IV II and III II and IV
B Since the individual is bullish, he should buy calls and/or write puts on the underlying stock. A bearish investor should buy puts or write calls.
Upon exercise of the option, the holder of a long put will profit if the price of the underlying stock: Falls below the exercise price Falls below the exercise price minus the premium paid Exceeds the exercise price Exceeds the exercise price plus the premium paid
B The buyer of a put profits if the market price drops below the exercise price by an amount exceeding the premium. For example, if an investor buys the XYZ July 50 put for 5, there will be a profit if the price drops below $45. If the price drops to $42, the investor could buy stock in the open market at this price and put (sell) the stock at the exercise price of $50. The net selling price will be $45 (exercise price of $50 minus the premium of $5). As the cost to buy the stock was $42, there would be a profit of $300. If the price dropped to $48, the investor would also exercise the put, but would have a net loss because the stock would be acquired at the market price of $48 and put to the writer at $50. The net selling price would be $45 after subtracting the premium, and the investor would, therefore, have a net loss of $300.
Which of the following statements is TRUE regarding the purchaser of a call option? The yield on the purchaser's portfolio increases by purchasing the option The purchaser's loss is limited to the premium if the underlying stock declines The purchaser benefits if the underlying stock declines The purchaser exercises the option if the stock declines
B The maximum loss that a purchaser of an option (call or put) can sustain is the amount of the premium paid. The purchaser of a call option profits if the underlying stock increases in value, and exercises a call only if the stock increases. Increasing the yield on a portfolio is a benefit of writing, not purchasing, call options.
A client buys 100 shares of XYZ Corporation at $27 per share and writes an XYZ October 30 call at a $3 premium. If the option is exercised, what is the profit or loss to the writer? A $300 profit A $600 profit A $300 loss None
B The profit for the covered call writer will be $600. The writer bought the stock at $27 per share. He received a $3 premium from the sale of the option. The writer will be able to share in the appreciation of the market price of the stock up to the strike price. When the option is exercised, the writer gives up the opportunity to realize any future gains above the strike price. If the cost of the stock is $27, and the option is exercised at the $30 strike price, the writer has a profit of $3 per share. Added to this is the premium received of $3 per share. This equals a profit of $6 per share or $600.
George has the following position in his account: Long 1 XYZ Nov 45 call By adding which of the following positions creates a combination? Long 1 XYZ Nov 45 put Long 1 XYZ Nov 40 put Short 1 XYZ Nov 50 call Long 1 XYZ Nov 50 call
B The purchase of a call and put on the same stock, with different expirations and/or strike prices, is a long combination. If the expirations and strike prices are the same, the purchases create a long straddle. To create a combination from the choices given, George needs to add 1 long XYZ Nov 40 put to his account.
An investor buys a DEF April 35 put at 3 and simultaneously writes a DEF April 30 put at 1. The maximum that the investor can lose on this position is: Unlimited $200 $300 $500
B This is a debit spread. The investor paid $200 more for the option purchased than he received for the option sold. If both options expire, he will lose the entire $200, which is his maximum potential loss.
To protect against a loss in a short sale, an investor can: Sell a call Enter a stop-loss order Buy a call Buy a put I or II only II or III only III or IV only I, II, or IV only
B To protect (not guarantee) against a loss in a short sale, an investor can either buy a call or enter a stop-loss order (buy-stop) to cover the short sale. The call option will appreciate in value to offset the loss on the short sale. The buy-stop order will limit the loss on the upside of the short sale. The short sale will then be covered since the stop order becomes an order to buy at the market when the stop price is reached.
An investor sold 5 JOJO April 70 calls for a premium of 6 points each. If the market price of JOJO is $74 these options have: An intrinsic value of 0 and a time value of 6 An intrinsic value of 2 and a time value of 4 An intrinsic value of 4 and a time value of 2 An intrinsic value of 6 and a time value of 0
C A call will have intrinsic value, also known as being in-the-money, when the market price of the underlying security is higher than the strike price. Since the underlying stock is $74 and the strike price is 70, the option's intrinsic value is 4. The remainder of the 6-point premium, 2, is time value.
An investor bought 5 NJF June 45 puts for a premium of 3 points per contract. For these options to have intrinsic value, the market price of NJF needs to be: Above $48 Above $45 Below $45 Below $42
C A put will have intrinsic value, also known as being in-the-money, when the market price of the underlying security is less than the strike price. In this example, the option gains intrinsic value below $45.
A writer of an uncovered call option would profit if the: Underlying common stock goes up Underlying common stock goes down Call expires Call is exercised with the stock price above the strike price plus the premium I and III only I and IV only II and III only II and IV only
C A writer (seller) of an uncovered call option does not own the underlying stock. If the underlying stock goes down, the call will expire unexercised. The writer will keep the premium paid by the buyer of the option and will no longer be exposed to a possible loss if the stock goes up. The answer is a writer of an uncovered call option would make money if the underlying common stock goes down and/or the call expires unexercised.
Customers will have unlimited risk if they are: Long 1 ABC Jan 50 put Short 1 ABC Jan 50 put Short 1 ABC Jan 50 put and short 100 shares of ABC stock Short 1 ABC Jan 50 put and long 100 shares of ABC stock
C An individual who is short stock has unlimited risk because there is no limit to how high the price may rise. The only protection offered by the short put is the premium received.
Which TWO of the following statements are TRUE about the market price of an option? The more volatile the underlying stock, the smaller the premium The current market price of the stock compared to the strike price influences the size of the option's premium The longer the period of time remaining until the option expires, the greater the premium Out-of-the money options have no time value I and II I and III II and III II and IV
C An option's premium is determined by the volatility of the underlying stock, the current market price of the underlying stock, and the time remaining until the option expires. The market price of the stock compared to the strike price determines whether the option is in- or out-of-the-money and the intrinsic value. An out-of-the-money option has no intrinsic value, its premium is all time value. The more volatile the underlying stock, the larger the premium. The longer the time remaining until the option expires, the greater the premium.
Mr. Jones purchases 100 shares of XYZ at $80 per share and writes an XYZ June 85 call receiving a $3 premium. If XYZ increased to $90 and the call option is exercised, Mr. Jones' profit is: $300 $500 $800 $1,800
C If the option is exercised, Mr. Jones will need to deliver his stock to the option holder at the 85 strike price. The IRS considers the proceeds of the sale to be the strike price (85) plus the initial premium received (3). Mr. Jones would, therefore, receive $8,800 for the stock that initially cost $8,000. His profit would be $800 ($8,800 - $8,000 = $800).
An investor writes an XYZ Aug 90 put at 4.50. If the put is exercised when XYZ is trading at 84.50, the investor will have: A cost basis of 84.50 A cost basis of 85.50 A loss of $100 if the stock is sold at the current market price A gain of $100 if the stock is sold at the current market price I and III I and IV II and III II and IV
C If the put is exercised, the writer will be put stock (must buy stock) at the strike price regardless of the current market price. The writer's cost will be 85.50 (the 90 strike price minus the premium of 4.50). Since the stock has a market price of only 84.50, liquidating the stock will result in a $100 loss.
Which TWO of the following choices are TRUE regarding the buyer of a combination? The buyer's maximum risk is unlimited The buyer's maximum risk is the total premium The buyer's maximum profit is unlimited The buyer's maximum profit is the total premium I and II I and IV II and III III and IV Explanation:
C The purchase of a call and put on the same stock with different expirations and/or strike prices is a long combination. If the expirations and strike prices are the same, the purchases create a long straddle. The buyer of a combination, or a straddle, expects the market price of the underlying security to be volatile. The maximum risk is the total premium, and this risk is realized if both options expire worthless. The maximum profit is unlimited since a long combination contains a long call.
A client purchased 300 shares of Emily Airlines common stock at $28 a share in July of 2011. In June of 2012, the client writes 2 October 35 calls at 5 against the stock position. If the market price of Emily Airlines is trading at $39 at expiration, what is the client's realized gain? $1,000 $1,700 $2,400 $4,300
C The question is asking for the client's realized gain. The investor is long 300 shares, but is writing only 2 covered calls. Since the market price of Emily Airlines (39) is above the strike price (35) at expiration, the call options will be exercised against the writer. The client will be obligated to deliver or sell 200 shares at $35. The realized gain on the stock is $1,400 (200 shares purchased at $28, which is sold at $35). The client received $1,000 from writing two covered call options (2 calls @ 500). Therefore, the total realized gain is $2,400. The client will still own 100 shares at a cost basis of $28.
On October 25, Mr. Smith purchased 5 listed XYZ Corporation July 50 calls and paid a $3 premium on each call. The current market price of XYZ Corporation is $48 per share. What is the breakeven point for Mr. Smith per option? $45 $48 $53 $58
C The strike price plus the premium equals the breakeven point for the buyer of a call. The breakeven point is $53 ($50 strike price + the $3 premium = $53).
What is a client's maximum loss if she is long XAM stock and short an XAM call? The difference between the market price and the strike price plus the premium The market price plus the premium The market price minus the premium Unlimited
C This is an example of a covered call (long stock + short call). The maximum loss is equal to the market price minus the premium. For example, if a client buys stock at $34 a share and writes a $40 call for a premium of 2, the maximum loss is $32. The investor's maximum loss would be incurred if the stock became worthless and the stock price went to zero. Without the hedge, the investor would lose the entire $34 per share. However, with the covered call, she at least has the premium of $200. That is why covered call writing is considered a partial hedge. The investor's only protection is the amount of the premium.
An investor purchases an ABC Jan 40 call @ 4 and sells an ABC April 30 call @ 9. This is an example of a: Variable hedge Vertical spread Horizontal spread Diagonal spread
D A spread involves the purchase and sale of the same type of options (calls or puts). If the contracts differ in expiration, it is a horizontal spread. If the contracts differ in exercise (strike) price, it is a vertical spread. If both expiration and exercise price are different, it is a diagonal spread.
Which of the following statements is TRUE regarding the writer of a put option? The writer has an obligation to sell stock if exercised The writer profits if he closes the position after the premium increases The writer has an unlimited loss if the put option is not covered The writer benefits if the underlying stock increases
D Choice (d) is true. The writer benefits if the underlying stock increases and the option expires. The other choices are not true. The writer has an obligation to buy stock if exercised, has a large but limited loss potential since the stock cannot fall lower than zero, and the writer profits if he closes the position after the premium decreases.
A customer writes an IBM October 120 call and receives a $4 premium and buys an IBM October 100 call and pays a $12 premium. IBM is currently selling at $108. Assume the customer later sells the IBM October 100 call for $20. The IBM October 120 call, which he initially sold expires. The customer will realize a: $400 loss $400 profit $1,200 loss $1,200 profit
D If the customer sold the call bought at $12 for $20, he will realize an $800 profit. If the call written for $4 expired, the $400 received will also be a profit. The customer will realize a $1,200 profit ($800 profit on the closing sale of the call + $400 from the call that expired = $1,200 profit).
An investor has purchased 1,000 shares of XYZ stock. Which of the following option transactions will provide the most effective means of reducing the cost of the stock? Buying 10 XYZ puts Selling 10 XYZ puts Buying 10 XYZ calls Selling 10 XYZ calls
D The investor will take in additional income by selling a call option. If the investor sells puts, she is obligated to purchase XYZ stock if the price falls. The most effective means of reducing the price of a stock purchase is to write a covered call.
Mr. Smith sells short 100 shares of MNP @ 39 and also purchases 1 MNP May 40 call @ 3. Mr. Smith's breakeven is: 36 37 42 43
D The purchase of a call will provide protection against a price increase in the short stock. If the stock price increases, the holder can exercise the call and buy the stock at the strike price. This limits Mr. Smith's loss. The breakeven is the short sale proceeds minus the premium paid for the call. This would equal 36 (39 - 3). If the stock price declines to 36, the 3-point profit on the short sale will be offset by the 3-point loss on the expiring call.
When an option contract is exercised, the writer: May retransmit the assignment notice May close out the position upon receipt of the assignment notice Will establish a capital loss Must fulfill the obligation to buy or sell the underlying instrument
D The writer must fulfill the obligation to deliver the underlying instrument for the exercise of a call or cash for the exercise of a put.
