Unit 4

Standardized equity options are issued and guaranteed by A) the Chicago Board Options Exchange (CBOE). B) the National Futures Association (NFA). C) the Commodities Futures Trading Commission (CFTC). D) the Options Clearing Corporation (OCC).

The OCC has the role of issuer and guarantor of all standardized equity options. That means if one party to an options contract fails to perform, the OCC steps in and takes that role (and then goes after the recalcitrant party). D)

Options positions can create either rights or obligations. In which option position has the investor created the possible obligation to purchase stock? A) Selling a put B) Purchasing a call C) Purchasing a put D) Selling a call

When you sell (write, go short) an option, you create an obligation. In the case of a put, you are obligated to purchase stock that is put to you. In the case of a call, you are obligated to sell stock that is called away from you. Options buyers have rights. They can choose what they wish to do; there are no obligations. A

The term derivative would apply to which of the following? A) DPPs B) UITs C) REITs D) Warrants

A derivative has its value based upon some underlying asset. The value of a warrant is based on the value of the security into which it is exchangeable. D

With respect to the specific commodity that is the subject of the contract, all of the following are standardized parts to an exchange-traded futures contract except A) the time for delivery. B) the market price. C) the quality. D) the quantity.

It is the delivery price that is standardized, not the market price (which is continuously fluctuating). Exchange-traded futures contracts offer standardized quantities and qualities (grade of the commodity), as well as a standardized time for delivery. B

One way in which futures contracts differ from options contracts is that A)both parties are obligated on futures contracts whereas only the buyer is obligated on an options contract. B)both parties are obligated on futures contracts whereas only the seller is obligated on an options contract. C)only the buyer is obligated on a futures contract whereas only the seller is obligated on an options contract.

Unlike options contracts, where only the seller of the option is obligated to perform (if the option is exercised), both parties to a futures contract are obligated to fulfill the terms. B

Buying a put option on a security one currently owns allows an investor to A) receive the premium for the purchase of the put. B) participate in additional gains if the security continues to increase in price. C) buy more stock if he exercises the put. D) increase his profit if the security declines in price.

This is an example of a protective put, that is, purchasing a put option on a stock the investor already owns. This allows the stockholder to lock in a sale price (the strike price of the put). If the market price of the stock continues to rise, the investor would not exercise the put. The put would expire, and the long stock would remain in the account at the higher market price. The investor could hold the stock or sell it at the higher market price.In either case, the investor would continue to participate in the additional gains. The protection (the hedge) occurs if the price of the stock falls. Then the investor would be able to exercise the right to sell the stock at the strike price. That would offset the loss on the long position, not generate additional profit. Remember that options buyerspay the premium; they do not receive it. Exercising a put gives the holder the right to sell the stock, not buy it. B

Which of the following are characteristics of newly issued warrants? A) Time value but no intrinsic value B) No intrinsic value and no time value C) Time value and intrinsic value D) Intrinsic value but no time value

Warrants can be thought of as call options with a long expiration period. They are always issued with a strike price in excess of the current market value, so there is no intrinsic value. One could say that, on issuance, they are always out of the money. The only value is in the time to expiration—usually several years or longer. A

Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? As an inducement to make the bonds more marketable To lower their interest cost on the issue To increase the marketability of their common stock To increase the number of common shares outstanding A) I, II, III, and IV B) I and II C) I only D) I and IV

Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate. B) I & II

An investor who was sure that a stock's price was going to move substantially but wasn't sure in which direction would be able to benefit by A) writing a straddle on that stock. B) purchasing the stock and a put on the stock. C) purchasing a straddle on that stock. D) selling the stock short and purchasing a call on the stock.

Purchasing a straddle on a stock means going long a put and a call at the same strike price with the same exercise date. If the stock goes up, the investor profits on the call; if the stock goes down, the investor profits on the put. When an investor writes a straddle, a put and a call are sold at the same exercise price and expiration date. Short straddles profit when the stock price remains stable (the opposite of what is presented in this question). Taking a long position in a stock with a long put offers protection to the downside but no profit. Likewise, shorting a stock and taking a long position in a call offers protection to the upside but no profit. C