Chapter 12 xx

The VIX (volatility index) is based on the:

S&P 500 Index

The settlement date between the Options Clearing Corporation and the clearing firm for options transactions is _______ business day from ____________

one, trade date

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:

$200 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.

Mr. Jones purchases a Canadian dollar September 85 call option for a premium of .82. At what price (spot rate) would the Canadian dollar need to be trading in order for Mr. Jones to exercise the option and break even? (Assume 10,000 Canadian dollars per contract.)

$0.8582 The breakeven formula for call buyers is the strike price plus the premium. The strike price is 85 (0.8500) and the premium is .82 ($0.0082). Therefore, the spot rate for the Canadian dollar would need to be $0.8582 for Mr. Jones to break even.

An individual purchases two BP (British pound) 150 calls @ 7.50. The contract size is 10,000 BP. The total cost for the contracts is:

$1,500.00 The total cost is calculated by multiplying the contract size (10,000) by the premium expressed in dollars ($0.0750), yielding $750.00 per contract. Since the individual purchased two contracts, the total cost is $1,500.00.

An investor writes 3 uncovered November 85 puts and receives a premium of $6 for each contract. What is the maximum profit that the investor can realize?

$1,800 The writer received $1,800 ($600 premium per contract times 3 contracts). If the options expire worthless, the investor will have no obligations, recognizing the entire premium as profit. This entire premium represents the most that the writer could profit.

An investor purchases one XYZ Corporation call with a strike price of 30. The investor pays $100 for the call. The market price of the stock is $29 . At expiration, the maximum amount of money the investor could lose is:

$100 The buyer of a call or put option pays a premium. The buyer paid $100 for the call, which is the maximum that can be lost.

An individual purchases an Australian dollar June 65 put at 2.34 that was sold at 3.68. If the contract size is 10,000 Australian dollars, what is the individual's total profit?

$134 The total cost is the contract size (10,000) times the premium expressed in dollars (decimal moved two places to the left, $.0234), which equals $234. Since the contract was sold at 3.68 ($368), the profit is $134.

An individual purchases 10 ABC June 90 calls @ 4 and writes 10 ABC June 95 calls @ 2. The individual's maximum loss is:

$2,000 Approach the questions as if the investor purchased the 90 call at the net debit of 2 ($2,000 for 10 contracts). The maximum loss when purchasing an option is the premium (net premium).

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 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. What is the maximum profit the investor can have?

$3,700 The investor can then buy 100 shares for pennies and put (sell) it to the writer for the $40 per share strike price. This equals $4,000 ($40 x 100 shares). The investors' profit is $4,000 minus the $300 premium paid for the put, which equals $3,700. The $3,700 is the maximum profit the investor can have since the share's price cannot go lower than zero.

An investor writes 5 uncovered ABC May 35 puts for a premium of 3 per contract, when ABC has a market price of $36. At what market price will the investor break even?

$32 The writer of a put calculates his breakeven point by deducting the $3 premium from the $35 exercise price. The writer, therefore, breaks even at $32. The breakeven point is a per-share price. The fact that the investor writes 5 contracts is not relevant.

An investor purchases an ABC Corporation October 50 put and pays a premium of $7. The underlying security declines to $40 per share. For tax purposes, the proceeds of the sale are:

$4,300 The proceeds of the sale for tax purposes are $4,300 ($5,000 strike price minus the $700 premium paid for the option equals the proceeds of the sale). The cost basis of the stock purchased is $4,000. The customer's profit is then $300.

Mr. Jones buys an XRX October 50 put when the market price of XRX is also $50 per share, and pays a premium of $5. If XRX declines sharply and Mr. Jones exercises the put, what is the maximum profit Mr. Jones can have?

$4,500 If the stock became worthless, Mr. Jones could then buy 100 shares and put it (sell it) to the writer for the $50 per share strike price, which equals $5,000 ($50 x 100 shares = $5,000). Mr. Jones would then make a profit of $5,000 minus the $500 premium paid for the put, which would be $4,500. The $4,500 is the maximum profit Mr. Jones could have since the stock could go no lower than zero.

An investor purchases 200 shares of STC at $35 and subsequently purchases 2 STC Jan 35 puts at 2. If the puts expire, what is the investor's profit or loss?

$400 loss When an option expires, the holder loses the entire premium. The client purchased two contracts at $200 each for a total loss of $400.

A short call position obligates the investor to:

sell shares if the option is exercised.

A customer buys 10 ABC January 50 calls paying a $3 premium and 10 ABC January 50 puts also paying a $3 premium when the market price of the stock is $49 per share. The buyer's TWO breakeven points are:

$44 $56 The breakeven point on the call is determined by adding the $50 strike price to the premium of $6. This equals a breakeven of $56. The breakeven point on the put would be six points below the strike price of $50, which equals $44.

With no other securities position, a customer sells short 100 shares of ABC at $40 and sells 1 ABC October 40 put for $500. The customer will break even when the price of the stock is at:

$45 If the price rises to $50 and the stock is bought in the open market to cover, the loss will be $1,000 minus the premium, for a net loss of $500. If the market price rises to 45, the loss of $500 is exactly matched by the premium income of $500 and the investor breaks even.

An investor makes an opening sale of 10 option contracts when the bid price was $7.00 and the offer price was $7.10. Later in the day, the investor makes a closing purchase of 10 contracts when the bid price was $6.50 and the offer price was $6.55. Assuming both trades were market orders, what is the investor's gain or loss on these transactions?

$450 capital gain In this case, the investor sold 10 contracts at the bid price of $7.00, for sales proceeds of $7,000 (10 contracts x $700 per contract). To close out the position, the investor bought 10 contracts at the offer price of $6.55, for a total cost of $6,550 ($655 x 10 contracts). The $450 capital gain is based on the difference between the cost basis and sales proceeds.

A customer buys an ABC July 50 call, paying a $3 premium. Seven months later, the customer exercises the call when the market price of ABC stock is $60 per share. The customer immediately sells the stock for $6,000. When computing the profit, the customer will use a cost basis of:

$5,300 The customer paid $300 for the call option plus $5,000 when he exercised the option at the $50 strike price. The customer's cost basis is, therefore, $5,300. The strike price plus the premium equals the cost basis for a buyer of a call who is exercising the option.

A customer owns a JRF October 50 listed call option. JRF has declared a $1.00 cash dividend. When JRF sells ex-dividend, which of the following choices will reflect the price and the number of shares of the JRF October 50 option?

$50 strike price, 100 shares Listed call options are not reduced for cash dividends. The strike price and the number of shares of the JRF October 50 option will remain the same after it sells ex-dividend.

A customer writes an XYZ June 60 straddle for a 5-point premium. At expiration, the market price of XYZ is 50 and the put side is exercised. The customer then sells the stock that was put to her at the current market price. The customer has realized a:

$500 loss The customer has received a total of $5 in premiums or $500 for the straddle. The call side of the straddle expires, but the put is exercised. The writer must buy the stock at $60 per share (the exercise price). The stock is then sold at the $50 market price, which results in a $1,000 loss ([$60 - $50] x 100 shares). However, since the customer initially received a premium when she wrote the straddle, the loss is only $500 ($1,000 loss from exercising the put - $500 premium).

An investor writes an uncovered ABC March 45 put for a premium of 4. At expiration, ABC is at $36 per share and the put option is exercised. If the stock is immediately sold by the writer at the current market price, what is the writer's profit or loss?

$500 loss When the stock is put to the writer, he must buy the stock for $4,500. His cost basis for tax purposes is $4,100 ($4,500 strike price - $400 premium received). Since he sold the stock for $3,600, he has a net $500 loss ($4,100 - $3,600).

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?

$53 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).

An investor is long 200 shares of ABC stock at $58 and short 1 ABC May 60 call at 2. What is his breakeven point?

$57 For positions like this, the first step in determining the breakeven point is to calculate the investor's net investment amount. In this question, the investor paid out a total of $11,600 (200 shares x $58 per share), but received $200 in premium on the sale of the call. Therefore, the investor's net investment amount is $11,400. The second step is to recognize that since the investor has a 200 share position, the $11,400 must be divided by 200 to determine the breakeven point of $57.

Ms. Green buys 300 shares of RSW at $15 per share. She then writes 3 RSW July 20 calls at 1 and writes 3 RSW July 10 puts at 50 cents. Ms. Green's maximum potential loss on the entire position is:

$7,050 If the market price of RSW is zero, the three covered calls will result in a $4,200 loss (300 shares x $15 purchase price minus the $300 premium received). The three uncovered puts will be exercised if the stock declines to zero, which is the worst case scenario. The maximum loss on an uncovered put is the total or aggregate value of the option less the premium received. The aggregate strike price of $3,000 ($10 x 100 shares x 3 contracts) minus the premium of $150 ($.50 x 100 shares x 3 contracts) equals $2,850. Therefore, the total loss is $7,050 ($4,200 + $2,850).

On December 16, a Mr. Smith purchased 2 listed XYZ May 70 calls and paid a $4 premium for each call when the current market price of XYZ Corporation was $69 per share. If, in May, the market price of XYZ Corporation is $67 and the calls expire, Mr. Smith loses:

$800 Mr. Smith will not exercise the call options. At expiration, the market price of XYZ is $67, which is less than the exercise price. Therefore, the options expire worthless. Mr. Smith loses $800 ($400 per contract times 2), the entire amount of the premium paid.

Mrs. Ima Holder purchased 10 RFQ July 60 calls. RFQ declares a 50% stock dividend. After the dividend has been distributed, Mrs. Holder now owns:

10 contracts for 150 shares each

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?

108 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.

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:

111 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).

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. According to SRO rules, when will the calls expire?

11:59 p.m. Eastern Time on the third Friday of the month

A customer owns an AMF October 30 call option. If AMF should split 2 for 1, the customer will own:

2 AMF October 15 calls each for 100 shares

An investor purchases a British pound 160 put at 4 when the British pound is at 157. The intrinsic value of the option is:

3

Mr. Smith sells short 100 shares of MNP @ 39 and also purchases 1 MNP May 40 call @ 3. Mr. Smith's breakeven is:

36 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)

An individual purchases one XYZ 40 call for 4 and one XYZ 50 call for 2. The market price of XYZ stock is currently 43. The individual's breakeven price is:

46 Buying two calls with different strike prices is a bullish strategy. In this example, since one of the strike prices is higher and out-of-the-money, it is less expensive than buying two calls with the same strike price. The total cost of the XYZ options is 6. The 40 call would be exercised first, resulting in a total cost of 46 (40 + 6)

An option contract for RFQ is for 108 shares. This is most likely a result of which of the following circumstances?

There has been a stock dividend

A customer buys an ABC July 50 call, paying a $3 premium. Seven months later, the customer exercises the call when the market price of ABC stock is $60 per share. The customer immediately sells the stock for $6,000. If the customer had sold the option at $8 instead of exercising the option, the profit would have been taxable as:

A $500 capital gain If the customer had sold the option at $8 instead of exercising it, the $5 profit per share ($8 sale minus $3 cost equals $5 profit) would be taxable as a capital gain.

____________________ always involves buying the higher exercise price and selling the lower exercise price.

A bear spread

______________________ always involves buying the lower exercise price and selling the higher exercise price.

A bull spread

In August, an investor sells an uncovered listed option and receives a $1,100 premium. The following February, the customer makes a closing purchase transaction at 3. The result of the transaction is:

A capital gain of $800 The investor made an $800 profit on the closing transaction (sale at $1,100 and purchase at $300). The profit is treated as a capital gain in the year the transaction is closed out.

A position in which a customer is long 1,000 shares of DEP and short 5 DEP September 50 calls is considered:

A covered option position only

In May, a customer sells an STC July 40 listed call for a $6 premium and buys an STC July 30 listed call for $10. The customer has created which of the following?

A debit spread executed for a cost of $400 which will be profitable if the price of STC increases Since the investor paid more for the purchase than she received on the sale, this is a debit spread which was executed for a cost of $400. Since the dominant leg is the long call, the position will be profitable if the stock price increases. A call debit spread is considered a bullish strategy.

______________ involves the purchase and sale of the same type of options (calls or puts).

A spread

An investor who sells a July 50 put and buys a July 60 put on the same stock is establishing a:

Bear spread

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:

Below $45

A client buys 5 EW April 75 puts and sells 5 EW April 80 puts. This type of strategy is:

Bullish 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 Swiss company that is expecting payment from a customer in U.S. dollars is concerned that the dollar will decline in value. To hedge against a decline in the U.S. dollar, the Swiss company should:

Buy Swiss franc calls

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 put options

Which TWO of the following option recommendations are suitable for a sophisticated investor who expects the overall market to fall but is bullish on mining stocks?

Buying narrow-based index calls Buying broad-based index puts

What Establishes a long position?

Opening Purchase

What Establishes a short position?

Opening Sale

What Liquidates an existing short position?

Closing Purchase

What Liquidates an existing long position?

Closing Sale

An investor purchases a PRT Oct 45 call @ 3. When PRT is selling at 51, the investor exercises the call. The investor has a:

Cost basis of 48 Since the question does not say that the investor sold the stock after exercising the call, it is not possible to calculate a profit or loss. The investor exercised the call and, therefore, purchased 100 shares of stock at a cost of 48 (45 strike price + 3 premium).

An investor wrote a 115 index option call. The option was exercised and the index closed at 125. The writer will:

Deliver cash Settlement on an index option contract is made in cash. The writer must pay the contract's in-the-money amount times $100.

Mike is long a yield-based put option in his account. Mike would like to see interest rates:

Fall

An investor who has owned XYZ stock for two years buys an XYZ October put. This will:

Have no effect on his holding period

A client has established the following position: Long 1 DEF May 50 call at 2Short 1 DEF May 40 call at 6 In which of the following situations will the client have the maximum potential profit?

If both options contracts expired unexercised This position is referred to as a credit call spread. It's a credit because the client received more for the short call with the lower strike price than what was paid for the call with the higher strike price. If both calls expire unexercised, the client will keep the net premium (the maximum gain). This will occur If DEF remains at or below $40 per share, since neither call will be exercised. If the stock price is trading below 44 (the breakeven point), the client may have a profit, but the maximum profit is realized if both options expired unexercised.

TUV Sep 5.00 puts trade on the CBOE. With the approval of its shareholders, TUV Corporation will reduce its outstanding shares by a factor of 20, which has the effect of increasing its market price 20-fold. What effect will this have on the TUV Sep 5.00 put?

Investors who previously owned 1 TUV Sep 5.00 put will now own 1 TUV Sep 100 put When a corporation's stock has a reverse or forward stock split, all associated options contracts are adjusted. When a reverse stock split occurs, the number of shares underlying each option will be reduced and the strike price will increase. In the case of a 1-for-20 reverse split, the number of shares underlying the contracts will be reduced to 5 (100 / 20), and the strike price will be increased by the inverse of the split ($5 x 20 = $100).

An investor is short 2,000 XYZ calls. In determining position limits, which of the following choices will be totaled with the short calls?

Long XYZ puts

When an option contract is exercised, the writer:

Must fulfill the obligation to buy or sell the underlying instrument

An investor selling a combination will profit if the price of the underlying security is:

Neutral

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?

Selling 10 XYZ calls 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.

Logan has the following position in his account. Long 1 DEF May 35 call. Logan anticipates a slight bullish move in DEF from which he wants to benefit, but he also wants some income generated to reduce the cost of the position without adding additional risk. He could accomplish this by adding which of the following positions to his account?

Short 1 DEF May 45 call By selling (short) 1 DEF May 45 call, Logan will generate income through the premium received and reduce the overall cost of the position. While the short call allows the owner to purchase DEF from him at $45 per share until it expires in May, Logan is long a DEF call that allows him to purchase the same stock at $35 per share until May

An employee in the operations department of a broker-dealer asks an Operations Professional what is meant by the term, covered XAM put. The BEST answer would be if it includes a position in which a customer is:

Short XAM stock

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 straddle

Which of the following positions would be considered a covered option?

Short the stock, short a put

In which of the following situations does an investor have unlimited risk?

Sold a put and is short the stock

An investor purchases 200 shares of STC at $35 and subsequently purchases 2 STC Jan 35 puts at 2. At what market price must STC trade for the investor to have a profit?

The stock must trade above 37 (35 cost + 2 premium).

An exercise limit is the maximum number of options contracts that a customer may exercise in a five-consecutive-business-day period for each:

Underlying stock on each side of the market

If a broker-dealer is assigned an exercise notice on Monday, May 2, on what day will the called stock settle?

Wednesday, May 4

Mr. Smith purchases 100 shares of MNP @ 30 and also purchases 1 MNP May 30 put @ 3. Mr. Smith is protected from:

a decline in the market until the option expires

If the expirations and strike prices are the same, the purchases create:

a long straddle.

The sale of uncovered options may be executed only in:

a margin account.

A put spread created for a net debit is _____________

bearish

If both expiration and exercise price are different, it is a ______________ spread.

diagonal

Investors can buy VIX calls to hedge against a _____________ in the S&P 500.

downturn

The Interbank market is the purchase and sale of foreign currencies among large banks. The market helps:

establish the cash (spot) prices for foreign currencies.

If the contracts differ in expiration, it is a _______________ spread.

horizontal

The purchase of a call and put on the same stock, with different expirations and/or strike prices, is a:

long combination.

There is _____________ ways the investor could profit from a put option.

more than one

This is an example of a credit spread (more premium received for the option sold than paid for the option purchased). In a credit spread, the investor will profit if the spread (difference in premium) _____________.

narrows.

Straddle writers expect a ____________ market and obtain the maximum gain if each option expires.

neutral

The majority of listed options contracts have a maximum life of:

nine months.

The longer the time remaining until the option expires, the greater the _______________________.

premium.

The writer of a combination expects the market to ___________

remain stable

The market price of the stock compared to the ____________ determines whether the option is in- or out-of-the-money and the intrinsic value.

strike price

A client with an options account takes the following position: Long GHI Nov 65 puts and Short GHI Nov 55 puts. This position will be profitable if:

the market price of the security declines.

Option trades (simple purchases or sales of calls or puts) settle on:

the next business day (T + 1)

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

A client buys 100 shares of MTB at $58 per share and writes 2 MTB October 60 calls at 3. The maximum loss is ________________.

unlimited

An uncovered (naked) call has:

unlimited risk.

If the contracts differ in exercise (strike) price, it is a ___________ spread.

vertical

The buyer of a combination expects the market to be ___________

volatile