Unit 10 Options Questions
On November 4, a customer writes an S&P 100 Jan 785 put at 6. The maximum potential gain on this position is A) 600. B) unlimited. C) 100. D) 300
A) 600. The potential gain on a short option is the premium received on the transaction.
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? A) A $2,630 gain B) A $2,630 loss C) A $4,750 gain D) A $4,750 loss
A) A $2,630 gain If the customer sold at 4.75 and purchased at 2.12, he nets 2.63, which is multiplied by 100 to yield a $263 gain per contract: 10 × $263 = $2,630 total gain.
If TCB is trading at 43 and the TCB Apr 40 call is trading at 4, what are the intrinsic value and the time value of the call premium? A) Intrinsic value: 3; time value: 1 B) Intrinsic value: 3; time value: 4 C) Intrinsic value: 4; time value: 0 D) Intrinsic value: 1; time value: 3
A) Intrinsic value: 3; time value: 1 The option is in-the-money by 3 points because the strike price is 40 and the market price is 43. This sets a minimum premium of $3 per share. Because the actual premium is 4, the balance of 1 represents time value. The premium, minus the intrinsic value, equals the time value. This is true whether the option is a put or a call.
Which of the following would be considered a bullish strategy? A) Writing a put B) A credit call spread C) Writing a call D) A debit put spread
A) Writing a put Those who write put options benefit when the price of the underlying asset increases (bullish). It is just the opposite for those who write a call. Spreads are bearish when the low strike price is sold and the high strike price is bought. That results in a debit when it is a put spread and a credit when it is a call spread. Credit put spreads and debit call spreads are bullish because it is the low strike that is purchased and the high strike that is sold.
A customer writes two ABC Jul 15 puts at 2 when ABC is 14. If the contracts are closed at a premium of 4 when ABC is 13, the customer has A) a $400 loss. B) a $200 gain. C) a $400 gain. D) a $200 loss.
A) a $400 loss. The investor receives $400 in premiums (2 × $200) and pays $800 to close out the options (2 × $400), resulting in a net loss of $400 ($800 − $400).
On exercise of the option, the holder of a long call will realize a profit if the price of the underlying stock A) exceeds the exercise price plus the premium paid. B) falls below the exercise price minus the premium paid. C) exceeds the exercise price. D) falls below the exercise price.
A) exceeds the exercise price plus the premium paid. To profit on a long call, the market price must exceed the strike price plus the premium paid (the breakeven point) computed using the call up rule.
Your customer is interested in buying call options on CDL common stock. The client asks you, "Who issues CDL options?" The proper response is A) the Options Clearing Corporation. B) CDL Corporation. C) the seller of the option. D) the exchange where the option is traded.
A) the Options Clearing Corporation. The issuer and guarantor of the options covered on the exam is the Options Clearing Corporation (OCC). Unlike other derivatives, such as rights and warrants, a corporation does not issue options on its own stock. Please do not confuse this with employee stock options, which is a different topic. As the guarantor, the OCC guarantees that the writer (seller) of the option will perform. That is, if exercised on a call, the stock will be delivered at the strike price, and if exercised on a put, the seller will pay the strike price.
A customer establishes the following positions: Buy 100 ABC at 28 Buy 1 ABC Dec 25 put at 2 What is the breakeven point? A) 26 B) 30 C) 23 D) 27
B) 30 The breakeven point is where an investor neither makes nor loses money. In this hedged position, the buyer must recover the cost of the stock and the premium paid to break even (28 + 2 = 30). Please note that the call up and put down rule does not apply when there is a stock position.
An investor owns six RIF Apr 150 puts. How many shares of the RIF will change hands if all the options are exercised? A) 900 B) 600 C) 150 D) 100
B) 600 Each of the six contracts allows the owner to sell (put) 100 shares of the RIF stock at $150 per share. If all six contracts are exercised, that will be 6 × 100 = 600 shares.
If an investor purchases 500 shares of an aggressive growth stock, which strategy would limit his downside risk? A) Buying five calls on the stock B) Buying five puts on the stock C) Writing five puts on the stock D) Writing five straddles
B) Buying five puts on the stock A put gives the investor the right to sell stock at a set price (the strike price) for a period of time, and it protects against losses below the strike price. Buying calls can protect a short stock position. If the customer is long stock, the purchase of calls on that security increases leverage and risk. Writing a put creates the obligation to buy more stock at the strike price, which increases downside risk.
A customer believes ABC's stock price will rise, but she 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 calls Write calls Buy puts Write puts A) I and III B) I and IV C) II and IV D) II and III
B) I and IV When the price of a stock that underlies a call option increases in price, the owner (holder) of that option stands to profit. An investor who has sold a put option on that stock will also benefit because the option will expire unexercised and the writer will get to keep the premium.
Which of the following is a bull spread? A) Short Aug 40 call, short Aug 40 put B) Long Jul 30 put, short Jul 35 put C) Long Aug 30 call, short Aug 25 call D) Long May 40 put, short May 35 put
B) Long Jul 30 put, short Jul 35 put A debit call spread is bullish and a credit put spread is bullish. Long Jul 30 put, short Jul 35 put is the only bullish position in the answer choices. Short Aug 40 call, short Aug 40 put is a short straddle, not a spread, and the remaining two positions are bearish: long Aug 30 call, short Aug 25 call and long May 40 put, short May 35 put. Remember, buying the low strike and selling the high strike is always a bull spread, regardless of the spread being puts or calls.
In a volatile market, which of the following option strategies carries the most risk? A) Credit spread B) Short straddle C) Long straddle D) Debit spread
B) Short straddle To establish a short straddle, the investor sells a call and a put; the short call carries unlimited loss potential.
On a single day, a customer purchases 15 TPL Sep 50 puts at 6 and 15 TPL Sep 50 calls at 1. If the price of TPL is $45 per share and the customer has no other security positions, what is this position called? A) Covered B) Straddle C) Combination D) Spread
B) Straddle A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. A straddle differs from a combination in that the strike prices and/or the expiration dates on a combination are different. A spread is a long put and a short put or a long call and a short call, rather than a put and a call.
Which of the following would be considered a bearish strategy? A) A credit put spread B) Writing a call C) Writing a put D) A debit call spread
B) Writing a call Those who write call options benefit when the price of the underlying asset declines (bearish). It is just the opposite for those who write a put. Spreads are bearish when the low strike price is sold and the high strike price is bought. That results in a debit when it is a put spread and a credit when it is a call spread. Credit put spreads and debit call spreads are bullish because it is the low strike that is purchased and the high strike that is sold.
Under FINRA rules, customers who are approved to trade options must receive a copy of the OCC Options Disclosure Document A) within 15 days of account approval. B) at the time of or before account approval. C) at the time of or before the mailing of the confirmation representing the first options trade. D) at the time of or before the mailing of the next monthly statement.
B) at the time of or before account approval. All customers who are approved by the ROP to trade options must receive a copy of the OCC Options Disclosure Document at or before the time the account is approved to trade options. It is the options account agreement that must be returned by the customer within 15 days.
If a customer writes one uncovered in-the-money put, the maximum loss to the customer is A) the strike price plus the premium multiplied by 100 shares. B) the strike price minus the premium multiplied by 100 shares. C) 100% of the premium. D) unlimited.
B) the strike price minus the premium multiplied by 100 shares. If the stock becomes worthless, the investor will be forced to buy the stock at the strike price, but they still keep the premium received when the option was written. Essentially, maximum loss is breakeven multiplied by 100 shares. The fact that the put was in-the-money when the option was written is of no consequence. It is only there to distract you.
With ABC stock selling for $49, a client sells one ABC 50 Nov call option in his cash account with your firm. One week later, ABC is now at $51 per share and his spouse sells two ABC 50 Nov calls in her account. In early November, ABC is selling for $62 per share and the spouse is assigned an exercise notice on one of the calls. The client calls and asks you, "Why was the exercise notice assigned to my spouse and not me?" You should respond: A) your broker-dealer assigns exercise notices based on LIFO. B) your broker-dealer uses random allocation when assigning exercise notices. C) your broker-dealer assigns exercise notices based on the market price at the time the option was written. D) your broker-dealer assigns exercise notices based on the larger position.
B) your broker-dealer uses random allocation when assigning exercise notices. When an option is exercised, the Options Clearing Corporation (OCC) determines the broker-dealer to whom it will be assigned by random selection. Broker-dealers then will assign the exercise to a customer with a short position in that contract. There are two common methods used. BDs can elect to use either random selection or first-in, first-out (FIFO). The options account agreement will specify which one the firm uses. The size of the position is never taken into consideration, nor is the market price at the time of the write. Last-in, first-out (LIFO) is not an acceptable manner for assigning options.
On December 13, an investor buys six 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? A) $225 B) $810 C) $1,350 D) $6,000
C) $1,350 Buyers of options lose premiums if the options expire unexercised. The most this investor can lose is the number of contracts (6) multiplied by the amount of the premium (2.25). This investor's maximum loss is $1,350.
A customer is short a DMF 50 call for which he received a premium of 4. Seven months later, the call was exercised when the current market for DMF was 56. Under the Internal Revenue Code, what were the proceeds of his sale? A) $5,000 B) $4,600 C) $5,400 D) $5,600
C) $5,400 He wrote a call and received a premium of 4. He later sold the security at $50, which made his total receipts for the stock $54. Proceeds in this case refers to the total amount he took in (a $400 premium plus $5,000 upon the sale).
If an investor buys one KLP Oct 95 put at 6.50, what is the investor's maximum potential gain? A) $9,650 B) $9,500 C) $8,850 D) $10,150
C) $8,850 The maximum gain on a long put is calculated by subtracting the premium from the strike price (95 − 6.50 = 88.50 per share). One contract represents 100 shares, so the buyer's maximum gain is $8,850 if the stock declines to zero. Because put buyers are bearish, they will make money if the stock falls below the breakeven point of 88.50.
If an investor sold two BCD Feb 40 calls at 4 on August 4, 2018, and the call expired unexercised, what were the tax consequences? A) $800 ordinary income for tax year 2019 B) $800 ordinary income for tax year 2018 C) $800 short-term capital gain for tax year 2019 D) $400 short-term capital gain for tax year 2019
C) $800 short-term capital gain for tax year 2019 For tax purposes, any premiums earned are recognized at the expiration date. In this case, the February call options sold in August 2018 for $400 each and expired in February 2019. Uncovered options writers always have short-term gains or losses.
An investor purchases 100 shares of JKL common stock at a price of $42 per share on April 22, 2018. On June 27, 2019, JKL's market price is $51 and the investor liquidates the position. Which of the following transactions made on October 17, 2018, would have an effect on the investor's tax treatment of this gain? A) Buying a Feb 45 JKL call B) Selling a Feb 45 JKL put C) Buying a Feb 45 JKL put D) Selling a Feb 45 JKL call
C) Buying a Feb 45 JKL put Long-term capital gains tax rates are available when one has a holding period of more than 12 months. Although this investor held the JKL stock for more than 14 months, the purchase of the put caused the holding period to be tolled (the IRS term for suspended). It means that the holding period from April 22 to October 17 (almost 6 months) is put on hold until the put is disposed of or expires. When that happens in February, the "clock" picks up where it left off and runs another 4+ months until June 27. The total time period is approximately 10 months, less than the 12 months required for long-term treatment. None of the other positions affects the holding period of a long stock position.
In the trading of options, there are a number of different multiple option strategies. An investor has the following position: Buy one RIF Apr 120 call Buy one RIF Jul 130 put Which strategy is the investor using? A) Long straddle B) Diagonal spread C) Long combination D) Time spread
C) Long combination A combination is composed of a long call and long put, or a short call and a short put, each having different strike prices and/or expiration months on the same underlying security. A straddle is when the expiration dates and exercise prices are the same. A spread consists of a long and short position in the same options class (two puts or two calls). In a diagonal spread, the exercise price and the expiration dates are different. In a time spread, everything is the same except the expiration dates.
Your client's position is long 100 MNO purchased at 90. Which of the following strategies will limit the customer's loss to $700? A) Short one MNO 90 call at 4, short one MNO 90 put at 3 B) Buy a MNO 90 call at 7 C) Long one MNO 90 call at 4, long one MNO 90 put at 3 D) Sell a MNO 90 call at 7
C) Long one MNO 90 call at 4, long one MNO 90 put at 3 It is the long put in this straddle position that limits the maximum loss on the long stock position. If the MNO stock drops to $0, the customer loses $9,000 on the long stock position but retains the right to sell the stock to someone at $9,000, to prevent loss beyond the premium of $300. The call would expire out of the money, for a total loss of $700.
When opening an options trading account, a broker-dealer is required by FINRA to A) deliver the OCC Options Disclosure Document to the customer within five business days of the account being opened. B) determine if the customer is approved for options trading at any other member firm. C) make sure the options agreement is signed and returned to the firm within 15 days of the account being approved. D) have the customer sign the options account agreement prior to or concurrent with the first trade in the account.
C) make sure the options agreement is signed and returned to the firm within 15 days of the account being approved. The options agreement must be signed and returned to the firm within 15 days of the account being approved. If it is not, then the only options activity permitted is closing transactions. A Registered Options Principal (Series 4) or Sales Principal (Series 10) signs off on the account approval. There is no requirement to determine the existence of accounts (options or otherwise) at another member firm.
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, because this strategy cannot be used in a joint account. B) suitable, because it has minimal risk characteristics. C) not suitable, because it is a speculative strategy with unlimited loss potential. D) suitable, because it is a standard strategy recommended to all retired customers to add income to their accounts.
C) not suitable, because it is a speculative strategy with unlimited loss potential. Writing naked calls has an unlimited loss potential and is considered a speculative option strategy. While it can be employed in any investment account (single or joint) to generate income, its speculative nature and unlimited loss potential would make it unsuitable for retired persons currently on a small fixed monthly income.
An investor buys two ABC Nov 50 calls, three ABC Dec 45 calls, and one ABC Jan 50 call. The best way to describe the portfolio is that it consists of A) six options of the same series. B) six options of the same type. C) six options of the same class. D) two options of one class, three of another class, and one of a third class.
C) six options of the same class. A class of options is when they are all of the same type (in this case, calls) and all on the same underlying security (in this case, ABC). Yes, they are all of the same type, but, in a question like this, FINRA is asking for the most specific answer. Same class is more specific than same type. The same series would be if they all had the same expiration date and exercise price.
Your client sells one naked MAV Oct 40 call at 2 when the market price of MAV is $41. What must MAV be selling at for the client to break even? A) 40 B) 38 C) 43 D) 42
D) 42 The breakeven point for a call is the strike price plus the premium (call up). The breakeven point is the same for both the buyer and the writer.
A customer establishes the following positions: Buy 100 ABC for 63 Write 1 ABC Jan 70 call for 1 What is the customer's maximum gain? A) 700 B) Unlimited C) 600 D) 800
D) 800 Maximum gain on the covered call position occurs when the stock's market value rises. The short call is exercised when the stock is above 70, so the stock bought for 63 will be sold for 70—a profit of $7 per share. In addition, the customer receives the premium of $1, so the total profit is $800 ($700 + $100).
In a strong bull market, which of the following positions utilizing leverage has the potential for the highest percentage gain? A) Holding stocks B) Writing puts C) Selling short D) Holding calls
D) 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. A put writer also profits in a rising market, but only by the amount of the premium. A short seller loses money if the stock rises.
A stock is trading consistently between $20 and $24. The investor with a long position is neutral on the stock. The goal is to generate income. Which of the following recommendations is most appropriate? A) Buy a put B) Sell a put C) Buy a call D) Sell a call
D) Sell a call The investor should sell a call on the stock and collect the premium (income). The investor is long the stock, so it would be better if the price goes up rather than down. Therefore, the sale of a call is better than the sale of a put, and those are the only real choices when the investor wants income through options.
Which of the following would establish a covered put? A) Long stock at 40, short put at 35 B) Long stock at 40, long put at 45 C) Short stock at 40, long put at 45 D) Short stock at 40, short put at 35
D) Short stock at 40, short put at 35 A covered put is created when a short stock is combined with a short put. Covered puts are established when the investor is neutral or slightly bearish; therefore, the strike price of the put is less than the cost of the stock sold short. The reason the put writer is covered (protected) is that if the stock's price should decline below 35 and the holder of the option exercises, the stock purchased by the writer is used to cover (replace) the borrowed stock for the short sale at 40.
A technology fund manager concerned about a downturn in the value of his portfolio would hedge by A) buying broad-based index puts. B) selling broad-based index calls. C) selling narrow-based index calls. D) buying narrow-based index puts.
D) buying narrow-based index puts. The portfolio consists of sector-specific securities, so broad-based index puts such as the OEX would not be appropriate. Instead, the manager should buy narrow-based index puts (for example, indices on technology and electronics).
All of the following option contracts are in-the-money when XYZ is 54 except A) long XYZ 60 put. B) long XYZ 50 call. C) short XYZ 45 call. D) short XYZ 50 put.
D) short XYZ 50 put. Call options are in-the-money whenever the market price is greater than the strike price. Put options are in-the-money whenever the market price is lower than the strike price. Try to remember: call up and put down.
If an investor establishes a call spread, and buys the lower exercise price and sells the higher exercise price at a net debit, he anticipates that A) the exercise prices will change. B) the price of the underlying stock will not change. C) the spread will narrow. D) the spread will widen.
D) the spread will widen. Debit spreads are profitable when both sides are exercised or the spread widens between the premiums. Credit spreads are profitable when both sides expire or the spread narrows between the premiums.
Which of the following positions subject an investor to unlimited risk? Short naked call Short naked put Long put Short sale of stock A) I and II B) I and III C) II and III D) I and IV
I and IV 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.
