Basic Options Transactions
If a customer writes 10 DEF Aug 50 calls at 1 when DEF is trading at 44, what is the maximum gain?
$1,000 Premium =1 # of contracts = 10 100 x 100 =1000
If an investor buys 1 KLP Oct 95 put at 6.50, what is the investor's maximum potential gain?
$8,850. 95-6.50 = 88.5 Stock can decline from 88.5- 0
On which of the following positions does the potential loss equal the premium?
Long Puts *The premium paid to acquire the option represents the most an investor stands to lose on a long option position. "Covered" and "uncovered" are terms that relate to short option positions.
Which of the following has the least amount of risks? Long a call in a rising market. Long a put in a falling market. Short a call in a rising market. Short a put in a falling market.
Long a call in a rising market. Long a put in a falling market.
An investor has researched XYZ Corporation and is convinced the company's stock will soon decline in value. If the investor wishes to act on that conviction, which investment strategy will allow the investor to take advantage of the anticipated decline in share value with the smallest cash investment?
Purchase a put option * If the stock declines as anticipated, the investor could exercise the put which allows the stock to be sold at the strike price and then repurchase it at its lower current market price for a profit.
Which of the following listed option positions is most unsuitable for a customer whose investment objectives include minimal risk?
Short Call
Which of the following has unlimited risk if it is the only position in an account?
Short Call Uncovered short calls carry unlimited risk.
Which positions subject an investor to unlimited risk?
Short Naked Call, Short Sale of Stock -Short stock and short naked calls subject an investor to unlimited risk because there is no limit on how high a stock's price might rise. Risk is limited for the other positions.
Calls BE (long or short) is
Strike price + premium
Calls (Long or short) are In-the-Money when
The market price is above the strike price
Puts (long or short) are In-the-Money when
The market price is below the strike price
All of the following can be advantages of buying an option contract EXCEPT
Time Value Dissipation The following ARE advantages- leverage, to position against a written option, to limit risk
A covered call could be written to:
improve the return on a portfolio.
If a customer writes 1 uncovered in-the-money put, the maximum loss to the customer is:
the strike price minus the premium multiplied by 100 shares.
If a customer closes his options position, he has
Placed either a buy order or a sell order *Closing an options position means taking a position that represents the opposite side of the opening transaction.
A stock selling for $62 is expected to decline temporarily in price, but the long-term trend is favorable. To take advantage of the temporary decline and generate income, the stockholder should:
Sell a Call *The sale of a call allows the investor to collect premiums. Because he owns the stock, the option is covered and no margin is required. Alternatively, the investor could buy a put to move more in-the-money as the stock price falls temporarily. He could later liquidate the put at a profit, but buying a put would not generate income.
Puts BE (long or short)
Strike price - Premium
What is the maximum potential loss for a naked put option?
Strike price - premium *BE to 0, because the stock price can only go as low as zero *The maximum loss on a naked put is equal to the breakeven (strike price minus premium for puts). The maximum loss is breakeven multiplied by the number of shares covered by the contracts. *BE to 0, because the stock price can only decline to zero
An investor establishes the following position: Long 1 XYZ Sep 40 call at 2 The maximum potential gain on the position is:
Unlimited Long Calls have unlimited MG, b/c a rise in stock price is unlimited
Which of the following strategies is considered most risky in a strong bull market?
Writing Naked Calls Writing naked calls gives unlimited risk. If the market rises, naked puts expire. In the latter case, the writer profits from the premiums
Which of the following transactions would be acceptable investments for a pension fund?
Writing a covered call *Writing a covered call has less risk than writing a naked option. A covered call writer is merely using options to increase the income on his portfolio. Fiduciaries such as those who invest for pension fund portfolios should avoid risky transactions.
When closing an option, a gain or loss is the difference between premiums paid and premiums received.
premiums paid and premiums received.
The investor with the greatest potential risk if the price of XYZ goes up is the one who is:
short calls
All of the following are advantages of buying a put versus selling stock short:
1) buying a put has a lower dollar-loss potential than does selling stock short. 2) buying a put would require a smaller capital commitment. 3) one need not locate securities to be borrowed to buy a put.
Call buyers' objectives include
1) diversifying holdings. 2) speculating for profit on the rise in price of stock. 3) delaying a decision to buy stock. Wrong Answer- Hedging a stock long stock position against falling prices (wrong bc a long stock (bullish) position is best hedge w/ purchase of long put which is bearish)
Compared with selling short, buying a put option:
1) does not require meeting the locate requirement for short sales. 2) requires a smaller capital commitment. 3) has a lower loss potential.
A customer long stock who wishes to reduce risk and generate income should:
Sell a call *If the customer sells a call, the risk of owning the stock is reduced by the call's premium; income (the premium) is generated by selling the option.
Which of the following option strategies besides going long a call can be used to purchase stock below its current market value?
Short Put *If the put is exercised by the owner the writer of the put will be obligated to purchase the stock. The cost of the stock is reduced by the amount of premium taken in when the put was written allowing the investor to purchase the stock at a net cost lower than the stock's current market value.
At expiration, the market price of the underlying stock is the same as the strike price of the option. Which of the following positions result in a profit?
Short Put, Short Call *B/c they are not exercised and the seller/writer profits from the prem. received.
At expiration, if the market price of the underlying stock is the same as the strike price, which of the following positions would be profitable?
Short options b/c they received the premium and the contract will NOT be exercised, as options writers prefer
On December 13, an investor buys 6 ABC Feb 60 calls at 2.25 each, when ABC is trading at 59.50 per share. If the calls expire unexercised, how much money will the investor lose?
$1,350 2.25 (prem.) x 6 (#of contracts) = 13.5 x 100 *Buyers of options lose premiums if the options expire unexercised.
A customer wrote 10 KLM Jun 80 calls for a premium of 4.75 at a time when the market value of KLM was 81.75. What is his gain or loss if he now closes out his positions at 2.12?
$2,630
An investor establishes the following position: Long 1 XYZ Jan 50 put at 2 The maximum potential gain on the position is
$4,800 *50-2= 48 *Long put is bearish and the stock can decline to zero, subtract prem. received from strike price.
Individuals with diversified stock holdings in their portfolios write covered calls to:
increase their rate of return on the stocks held in their portfolio. *Covered call writing is frequently used by persons who own the underlying stock to increase rate of return. If the options expire unexercised, the writer keeps the premium, which provides additional portfolio income.
Which options positions have unlimited loss potential?
short uncovered calls *b/c a stocks price can rise indefinitely
If an investor maintaining a short equity option is assigned an exercise notice, which of the following statements is TRUE?
He must accept the exercise notice. *Once exercised, a contract may not be traded to another individual. The exercised party must either deliver (call) or buy (put) the stock in 3 business days.
A person who buys a put will be profitable if just before expiration the price of the underlying stock is
A) less than the exercise price *A long put is profitable if the price of the underlying stock falls below the exercise price at least by the amount of the premium paid; if the price rises above the exercise price or is the same as the exercise price, the put will expire worthless.
Your clients, an elderly retired couple on a small fixed monthly income, want to write uncovered (naked) calls in their joint account to generate income. For this account this option strategy would most likely be deemed:
A) not suitable as this is a speculative strategy with unlimited loss potential
In a strong bull market, which of the following positions has the potential for the highest percentage gain?
Holding Calls *Both a long call and a long stock position are profitable in a rising market. However, because options use leverage, the profit relative to the money invested is larger with option positions.
Buying a put option on a security he holds allows an investor to
1. Participate in additional gains if the security continues to increase in price. 2. Protect a profit on his current stock position. *Purchasing a put allows the stockholder to lock in a sale price. If the price continued to rise, the investor would not exercise the put. He would let it expire and sell the stock at the higher market price thus continuing to participate in the additional gains. If the stock fell the investor would exercise the right to sell the stock at the strike price and in this way protects a gain on the stock. Remember that options buyers pay the premium, they do not receive it, and exercising a put gives one the right to sell the stock, not buy it.
If a customer writes one uncovered in-the-money put, the maximum gain would be:
100% of the premium *The maximum gain to an option writer is the premium received.
If a customer sells 3 DEF Feb 25 Puts at 4 when DEF is at 24, the maximum potential gain is:
1200 *The maximum gain when a put (or any option) is sold is the premium received. Since there are 3 contracts, the gain is 3 multiplied by $400, or $1,200.
On November 4, a customer writes an S & P 100 Jan 785 put at 6. The maximum potential gain on this position is:
600 The potential gain on a short option is the premium received on the transaction.
A customer who writes (sells) a naked call will profit if:
A) the option contract expires without being exercised by the owner. *The writer of a call will profit if the contract expires unexercised. In which case, the premium received when the contract was written will be the profit.
Which of the following positions exposes a customer to unlimited risk?
All of the following 1) Short 2 XYZ calls. 2) Short 200 shares of XYZ and short 2 XYZ puts. 3) Short 200 shares of XYZ.
A Disadvantage of Buying a Put is
The dissipating Time Value
If a customer bought a put option and the underlying security declined, the put would probably:
Be exercised
An investor would sell a put because he is
Bullish, wants income, doesn't want option to be exercised
A customer believes ABC's stock price will rise, but does not currently have the money to buy 100 shares. How could the customer use options to profit from a rise in the stock's price?
Buy a Call , Write a Put * Both have a bullish market attitude and will cost less than buying 100 shares of the underlying stock.
All of the following accounts are permitted to write calls EXCEPT:
D) a corporation against its own stock. Allowed- A) a custodian in an UTMA account against a long-stock position. B) an individual in a margin account. C) a mutual fund against a long stock position.
Which investor has the greatest potential risk if the price of QRS goes up?
Short 10 calls on QRS.
Concerns for an investor Writing a Naked Option
The loss potential The Possibility of Exercise The Risk/ Reward ration Not a concern: The premium the investor must pay for a contract- WRONG b/c the writer Always receives the prem.
The market attitude of an investor with no other position who writes an at-the-money call is:
bearish/ neutral
