FIN 3504 Ch. 15
A put option is available on the stock of Rally Corporation. The exercise price is $65. The put option price is $1. Rally stock is currently selling for $70 per share. What is the "intrinsic value" of the put option?
$0 The intrinsic value is the minimum value an option will trade for and equals the strike price minus the FMV of the stock for a put option. In this case, the intrinsic value equals $0 ($65 - $70) - it cannot be less than zero. The intrinsic value is not influenced/impacted by the option price
An investor buys 100 shares of XYZ stock for $40 and simultaneously writes 1 XYZ November 40 call at $3. If the investor closes both positions three months later when the XYZ is trading at $45 and the November calls are at $6, what is the result?
$200 profit Stock position 100 x ($45-$40) = $500Option position ($6-$3) x 100 = ($300)$500 - $300 = $200
Jace owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion price equals:
$40 The conversion price equals the par value of the bond ($1,000) divided by the conversion ratio (25), which equals $40.
Maximum gain on a long call
(S - X - P)
Gerry expects the market to rise. Which of the following option strategies should he follow: 1. Long call 2. Long put 3. Short call 4. Short put
1 and 4 Long a call (buy), short a put (sell).
Jace owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion ratio equals:
25 The conversion ratio equals the number of shares of common stock that the bondholder will receive if the bond is converted
Out-of-the-money
A call option that is out-of-the-money has an exercise price that is above the market price for the underlying security. A put option that is out-of-the-money has an exercise price that is below the market price for the underlying security.
Clarissa holds a concentrated position in XYZ stock, which she purchased 15 years ago for $6 per share. The price of XYZ stock is currently at $100 per share, and Clarissa is happy with the gain that she has achieved. She realizes that it is a good idea to diversify her portfolio, but selling all of the stock in the current year will result in a large tax burden. Which of the following strategies would allow Clarissa to sell some of the shares this year, and delay selling some of the shares until next year to help ease the tax burden, but will lock in her sale price within a reasonable range of the current price?
A collar A collar strategy involves the simultaneous purchase of a put option and sale of a call option, with the same expiration but different strike price. For example, Clarissa might be able to purchase a put option with a strike price of $90 that expires next year in February, by paying a premium of $4. At the same time, she may be able to sell a call option with a strike price of $105 that expires in February of next year, and receive a premium of $4. This would be called a "zero cost collar" since the premium she paid for the put is exactly offset by the premium she received for writing the call. In February of next year, if the price of XYZ stock has risen above $105, the holder will exercise and Clarissa will sell at $105. If the price falls below $90, Clarissa will exercise her put option and sell at $90. She has "collared" her sale price between $90 and $105 for the next tax year.
Writing a call option on the S&P 500 Index results in:
A gain if the S&P 500 Index falls Writing a call option on the S&P 500 index results in a premium to the writer. The writer loses money if the index increases. The writer's maximum gain (premium) results if the price of the index decreases.
An investor buys 1 ZZZ Dec 95 call at $5. When ZZZ increases to 99, the call is exercised and the stock is immediately sold. What is the result?
A loss of $100. ($4 gain from stock price x 100 shares) - ($5 premium paid x 100 shares) = Loss of $100
A contract that gives its owner the right to sell a specified asset at any time prior to expiration is called:
A put option contract Options give the holder the right to either buy or sell. A put option gives the holder the right to sell the underlying asset (generally stock) at the strike price. Futures and forward contracts are designed to make or take delivery at a specified period of time in the future.
Which of the following option positions represents the most risk to an investor?
A short straddle A short straddle is a short call combined with a short put on the same underlying security, each having the same strike price and exercise month. With a short straddle, the investor makes money if the stock price remains constant. The investor can lose if the stock price decreases or increases. The larger the price change, the larger the loss. If the market price of the underlying stock increases, the short call can be exercised against the investor. Because the stock price can increase without limit, the short straddle has unlimited loss potential.
Option contract
A standard option contract represents 100 shares but is quoted on a per share basis
Writer
Also known as the seller Person obligated to either sell (call option) or buy (put option) the underlying security at the specified price in the contract
Maximum gain on short options
Always equal to the premium
Maximum loss to a long option
Always equal to the premium.
At-the-money
An option is at-the-money when its exercise price equals the market price for the underlying security for both calls and puts. Zero intrinsic value
In-the-money
An option that has a positive intrinsic value A call option is in-the-money when its exercise price is below the market price for the underlying security A put option that is in-the-money has an exercise price that is above the market price for the underlying security
What is the investor's strategy for profit if they buy 1,000 shares of LMT stock at $71 and also 10 LMT July puts at $2?
Bullish The put is to protect the downsides risk. The investor is bullish because the investor is long the stock.
An investor purchased a put option with a strike price of 82 and wants to combine it with another option with on the same stock with the same expiration date to create a long strangle position. Which of the following actions should the investor take?
Buy a call option with a strike price higher than 82 A long strangle consists of a long put and a long call option with a higher strike price. As the investor already has a long put with a strike price of 82, she needs to add a long put with a strike price higher than 82.
Exercising the option
Compelling the seller of the contract to sell the underlying security for a call option or to buy the underlying security for a put option.
For a call option contract, the price at which the option holder can buy the underlying security is called?
Exercise price. The price at which a call option holder buys the underlying stock is called the exercise price or the strike price.
Jacinda buys 10 DEF 65 call options for $7 when the price of DEF is $61. Jacinda sells the call options for $16. What is her gain or loss?
Gain of $9,000. Jacinda bought the calls for $7,000. Remember, 1 option contract represents 100 shares of stock. She sold the calls for $16,000. Therefore, her gain equals $9,000.
Call options
Gives the owner the right to purchase the underlying security at a predetermined price over a specified period of time
Put options
Gives the owner the right to sell the underlying security at a predetermined price over a specified period of time
An "at the money call":
Has intrinsic value = 0 An "at the money call" is strike price equal to the market value, which is an intrinsic value of zero.
Maximum loss on short options
Is unlimited (P - (S - X))
An investor believes there is an equal chance of GJR stock increasing or decreasing in price significantly. Which of the following option strategies is the investor most likely to use?
Long Straddle A long strangle will profit if the stock moves significantly higher or lower. A movement in either direction will be equally profitable. A strip is appropriate when an investor is more bearish.
Rascal has entered into a contract to buy 100 shares of Rally stock for $40 per share anytime over the next six months. He has a:
Long position in a call option. A call option gives the holder the right to purchase the underlying security at a specific price within a specific period of time.
Kanye believes that XYZ stock will increase in value. He buys 20 XYZ March 60 call options for $4 when the price of XYZ is $61. If XYZ falls to $55 and stays there through March, what will be Kanye's gain or loss?
Loss $8,000 Kanye paid $8,000 (2,000 options x $4). $8,000 is the premium paid and is the maximum loss if the contract expires.
Nimoy buys 20 call options on XYZ March 60 for $5 when the price of XYZ is 61. XYZ falls to $40 and remains there through March. What is Nimoy's gain or loss?
Loss 10,000 The options will expire worthless and Nimoy will lose the premium paid for the options.5 x 20 options x 100 shares = 10,000 Loss
Strike price
Price at which the option holder (buyer) can exercise the option
Which of the following positions has the greater risk for investors?
Shorting a stock The maximum loss for a long call is the premium paid. The risk for a covered call is to lose the stock, which is a loss of upside potential. A covered put involves writing a put for a stock that has been sold short. The put premium offsets some of the downside risk. The short sale of a stock is the riskiest position since the short seller must repurchase the stock in the open market if the stock price increases.
A writer of a call option:
Sold a call option The writer of a call option is the seller of the option and receiver of the option premium.
When someone "writes" a call option, they have:
Sold a call option The writer receives the option premium for selling the call options.
When someone "writes" a call option, he has:
Sold a call option.
Premium
The cost of the option Intrinsic value + time value of the option.
If a farmer buys a wheat put option on futures:
The farmer has the right to assume a short position in the underlying wheat futures at the option strike price. Wheat options are option contracts in which the underlying asset is a wheat futures contract. The holder of a wheat option has the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying wheat futures at the option strike price. This right expires when the option expires after market close on expiration date.
Regarding a short straddle:
The maximum loss is unlimited A short straddle consists of a short put and short call. Gain is limited to the premiums. Losses are unlimited on the call side.
Intrinsic value
The minimum price at which an option will trade Can never be less than 0 Intrinsic value of a call option = stock price - strike price Intrinsic value of a put option = exercise price - stock price
The conversion ratio of a convertible bond equals:
The number of shares of common stock that the bondholder will receive if the bond is converted.
Payoff
The positive difference between the strike price and the underlying security price upon exercise of the option. Call option payoff = (S - X) Put option payoff = (X - S) S = price of underlying security X = exercise or strike price of the option Zero if the option is not exercised Excludes premiums
What is the investor's strategy for profit if they buy one ABC July 60 call at $3 and buys one ABC July 50 put at $1?
Volatility. This strategy is known as a strangle. The position will be profitable only if the stock moves far enough above the strike price of the call option, or below the strike price of the put option. The investor is therefore not necessarily bearish or bullish, but requires volatility.
Long call position
When an investor buys a call option The investor believes that the underlying security will increase in value Profit or loss = Payoff - Premium
Short put position
Where a trader sells a put option on a security The trader's goal is to profit from an increase in the stock's price by collecting the premium associated with the sale
Long put position
Where an investor buys a put option The investor believes that the price of the underlying security will fall below the strike price before the expiration date
Short call position
Where an investor sells a call option on a stock The investor expects the stock's price to decrease in the future Profit or Loss = Premium - Payoff
