FI 414 Chp 14

For a call purchased on an organized security exchange, the strike price specifies the... A) contractual price at which each of the shares of the underlying stock can be bought. B) prevailing market price of one share of the underlying stock. C) cost of buying one option contact based on the value of the underlying stock. D) intrinsic value of the offsetting put.

A

The option premium is... A) the market price of the option. B) the amount by which the stock price is expected to move before the option expires. C) the fee charged by the options exchanges for executing transactions. D) the difference between the strike price and the underlying price of the security.

A

Jamie wrote a nine-month put on Beta stock. The strike price was $25 and the market price at the time the option was written was $24. The total price of the option contract was $150. At what market price will Jamie just break-even on this investment? Ignore transaction costs and taxes. A) $23.50 B) $24.00 C) $25.00 D) $26.50

A) $23.50

Grant purchased one call on XYZ stock at an exercise price of $25. The market price of XYZ stock when Grant purchased the call was $24 a share. XYZ is currently priced at $30 a share. Grant paid $120 to buy the call. How much profit will Grant make if he exercises the option today and then sells the shares? Ignore all transaction-related costs. A) $380 B) $480 C) $500 D) $600

A) $380

The price of ABC stock is currently $42 per share, but in six months you expect it to rise to $50. ABC does not pay a dividend. You buy a six-month call on ABC, with a strike price of $45. The option cost $200. What holding period return do you expect on this call? Ignore transaction costs and taxes. A) 150% B) 200% C) 250% D) 300%

A) 150%

In January, JB stock was selling for $50 per share. When the calls and the puts with a strike price of $45 expired on March 20, JB was selling at $46. Which investors made a profit? I. the writer of the call II. the buyer of the call III. the writer of the put IV. the buyer of the put A) II and III B) I and III C) only III D) II and IV

A) II and III

Which of the following increase(s) the time premium of a call option? I. a market price that exceeds the strike price II. increasing volatility in the market price of the underlying security III. decreasing market interest rates IV. decreasing the time to option expiration A) II only B) I and II only C) III and IV only D) II and III only

A) II only

Stocks options that trade in the January cycle will have contracts available that expire in... A) January, February, April, and July. B) March, June, September, December. C) January, February, March, and April. D) each of the next 12 months.

A) January, February, April, and July.

Which of the following is a possible official expiration date for a standardized option contract? A) Saturday, October 17 B) Monday, March 1 C) Friday, April 30 D) Wednesday, May 19

A) Saturday, October 17

Tiffany would like to own shares of Blackwood, Inc. but only if she can acquire them at a total cost of $30 a share or less. Blackwood is currently trading at $31.76. Cynthia should ________ with a strike price of $30. Ignore transaction costs. A) buy a call B) buy a put C) write a call D) write a put

A) buy a call

In nearly all cases, the purpose of a hedge is to... A) reduce or eliminate risk. B) make a very high profit in an extremely short time frame. C) speculate on a downward drop in a general market index. D) speculate on an upward movement in a given currency.

A) reduce or eliminate risk.

A put has fundamental value as long as... A) the market price of the underlying financial asset has a positive value. B) the market price of the underlying financial asset is less than the strike price. C) the strike price of the put is greater than the time premium of the put. D) the strike price of the put is less than the market value of the underlying asset.

B

NZMA stock is currently selling for $128. Which of the following options is "in-the-money"? A) March 130 call B) February 125 call C) March 125 put D) February 100 put

B

One reason that writing options can be a viable and profitable investment strategy is that... A) the option writer collects the quarterly dividends. B) most options expire unexercised. C) an option writer determines when the option is exercised. D) an option writer can exercise the option to avoid a potential loss.

B

What is the time value of a put with a strike price of $30 when the option price is $500 and the underlying common stock sells for $27? A) $100 B) $200 C) $300 D) $400

B) $200

Rex bought a put on Alpha stock with a strike price of $35 when the market price of Alpha stock was $33 a share. Alpha is currently selling at $34 a share. Which of the following statements are true given this information? I. Rex's option is worth at least $100 today. II. Rex's option is worthless today. III. Rex's option has more value today than when he bought it. IV. Rex's option has less value today than when he bought it. A) I and III only B) I and IV only C) II and III only D) II and IV only

B) I and IV only

Which of the following represent in-the-money options? I. a call when the market price exceeds the strike price II. a call when the strike price exceeds the market price III. a put when the market price exceeds the strike price IV. a put when the strike price exceeds the market price A) I and III only B) I and IV only C) II and III only D) II and IV only

B) I and IV only

Quotations in an option chain will show... I. the most recent bid and ask prices of the option II. puts and calls for the same expiration date. III. the strike price. IV. the highest and lowest price for the option in the previous month. A) I, III and IV only. B) I, II and III only C) II, III and IV only. D) I, II, III and IV

B) I, II and III only

Which one of the following actions would be the most appropriate hedge to a short sale of common stock? A) sale of a call B) purchase of a call C) sale of a put D) purchase of a put

B) purchase of a call

For all practical purposes, listed stock options always expire... A) on the last business day of the expiration month. B) on the first Monday of every calendar quarter. C) on the third Friday of the expiration month. D) three months from the date of the option purchase.

C

The strike price of a put option is the price... A) an investor must pay for the options contract. B) of the underlying stock at the time that the options contract is purchased. C) at which the underlying stock can be sold. D) at which the underlying stock can be bought.

C

The writer of a put or call is the... A) the institution that brings buyers and sellers of an option together in a transaction. B) can limit risk by letting the option expire unexercised. C) party who creates an option by selling it. D) party who guarantees that the terms of the option will be satisfied.

C

Jason purchased a six-month put on ABC stock at a cost of $100. The strike price was $15. At what market price does Jason just break-even on this investment? Ignore transaction costs and taxes. A) $15 B) $16 C) $14 D) cannot be determined from the information provided

C) $14

Roselle paid $250 to buy one put option with a strike price of $35. What is the maximum profit Roselle can earn on her option contract? A) $100 B) $350 C) $3,250 D) Her profit potential is unlimited.

C) $3,250

Which of the following variables are part of the Black-Scholes option pricing model? I. the market price of the underlying stock II. the volatility of the underlying security III. the strike price of the option IV. the risk-free rate of interest V. the beta of the underlying security VI. the time remaining before the option expires A) I, II, IV and VI only B) I, II and III only C) I, II, III, IV and VI only D) I, II, III, IV, V and VI

C) I, II, III, IV and VI only

Kyle believes the price of Ajax stock is about to decrease. If he wants to profit from the decline in price, he should ________ on Ajax stock. A) buy a call B) write a put C) buy a put D) sell a put

C) buy a put

Purchasers of stock options A) own a financial asset with benefits of firm ownership. B) have a claim on the profits of the firm issuing the underlying securities. C) have the obligation to buy or sell a predetermined amount of shares at the strike price. D) have the right to buy or sell a certain number of underlying shares.

D

Fred bought 600 shares of Edgewood stock at a price of $19. The stock is currently selling for $53 a share. To protect his profits, Fred should buy... A) 600 call options with a strike price of $55. B) 600 put options with a strike price of $50. C) 6 call options with a strike price of $55. D) 6 put options with a strike price of $50.

D) 6 put options with a strike price of $50.

Shares of Lakewood, Inc. are currently selling for $52.63. You believe the stock will decline in price ranging from $30 to $32 in the next few months. Which of the following strategies will allow you to profit if your prediction is correct? I. short the stock II. buy a call at 50 III. write a call at 55 IV. buy a put at 45 A) II and IV only B) I and III only C) III and IV only D) I, III and IV only

D) I, III and IV only

The value of a put increases as the price of the underlying security rises.

False

Writing covered calls protects the writer from losses if the price of the underlying stock declines.

False

Because puts and calls derive their value from the behavior of some other real or financial asset, they are known as derivative securities.

True

European options can only be exercised on the expiration date but can be sold to another investor on any trading day.

True

For a spread to be successful, the difference in strike prices must be greater than the net cost of the purchased option(s).

True

For the writer of in-the-money covered calls , losses on the options contract will be nullified by gains on the stock.

True

Investors who purchase options acquire nothing more than the right to buy or sell the shares of the underlying security.

True

Once the call premium is recouped, the profit from a call is only limited by the price increases of the underlying stock prior to the contract expiration.

True

One of the primary advantages of options is the leverage they provide.

True

Options allow investors to speculate on price movements without a large initial investment.

True

Options can provide a lot of price action for a limited dollar investment.

True

Paul writes a put with a strike price of $35. The most he could lose by writing the put is $3,500.

True

Rights are call options issued to current owners of the stock and normally expire within a short period of time.

True

The majority of today's options are stock options traded primarily on the CBOE and on AMEX.

True

The maximum amount the buyer of a put can lose is the cost of the option.

True

The maximum loss that can be incurred as the buyer of an option is the amount of the option premium.

True

The option premium is the price of the option.

True

The writer of an option creates the option by selling it.

True

The ability to obtain a given equity position at a reduced capital investment, and therefore magnify returns, is known as... A) leverage. B) straddling. C) hedging. D) triple witching.

A

Which of the following statements concerning put options are correct? A) The writer of a put profits if the price of the underlying stock rises. B) The writer of a put profits if the price of the underlying stock falls. C) The owner of a put profits if the price of the underlying stock rises. D) Both the owner and writer of a put profit when the price of the underlying stock falls.

A

An American call option gives the owner... A) the right to buy or sell the stock at the strike price on or before the expiration date. B) the right but not the obligation to buy the stock at the strike price on or before the expiration date. C) the right and the obligation to buy the stock at the strike price on or before the expiration date. D) the right but not the obligation to sell the stock at the strike price on or before the expiration date.

B

The buyer of a listed American option has which of the following rights? I. the right to change the expiration date II. the right to change the strike price III. the right to resell the option IV. the right to let the option expire unexercised A) I and III only B) III and IV only C) I, III and IV only D) II, III and IV only

B

The two provisions which investors should carefully consider when evaluating stock options are the... A) strike price and the exchange ratio. B) time until expiration and the strike price. C) leverage ratio and the time to maturity. D) premium and the discount.

B

The writer of a put option hopes that the price of the underlying stock will rise because A) the option is more likely to be exercised. B) the option is less likely to be exercised. C) the buyer of the put will have to purchase the stock at a higher price. D) the value of the put option will increase in the secondary market.

B

Warrants are generally created when... A) a firm decides to execute a stock split. B) the issuing corporation decides to sweeten a bond issue. C) a LEAP expires and automatically converts. D) a financial institution decides to create them based on market conditions.

B

Nowel Inc. stock is currently priced at $42. The present value of the strike price of a call option on this stock is $44. Probability one, as calculated by the Black Scholes option pricing model is .6541; probability 2 is .3722. The value of this option as calculated by Black-Scholes is A) $(2.00). B) $11.10. C) $2.000. D) $10.71.

B) $11.10.

Andrea wrote a three-month call on Echo stock. The option cost $200 and the strike price was $10. What does the market price of Echo have to be for Andrea to break-even on this investment if the option is exercised? Ignore transaction construed taxes. A) $10 B) $12 C) $8 D) cannot be determined from the information provided

B) $12

The most important factor affecting the market price of a put or call is the... A) market interest rate. B) expiration date. C) price behavior of the underlying common stock. D) price behavior of the corresponding warrant.

C

Warrants... A) provide substantially less capital appreciation potential than the underlying stock. B) tend to be quite costly. C) have a stipulated price and an expiration date. D) are not traded in the secondary markets because of their low unit costs.

C

Which of the following is true about rights? A) They are usually attached to bonds as a "sweetener" B) The owner has several years in which to exercise the option. C) They are a type of short-lived call option. D) They are a type of short-lived put option.

C

What is the fundamental value of a put contract with a strike price of $25 when the option price is $1.50 and the underlying common stock sells for $26? A) $150 B) $100 C) $0.00 D) -$100

C) $0.00

Steve bought 300 shares of stock at a price of $20 per share. The price of the stock then went up to $33 per share so Steve decided to hedge his position by purchasing 3 puts at a cost of $120 each. The puts have an exercise price of 30. One week prior to the expiration of the puts, the price of the stock was at $22 per share. If Steve closed out all of his positions at that time, he would have earned a net profit of... A) $200. B) $240. C) $2,640. D) $3,000.

C) $2,640.

Lew paid $300 to purchase a call on Delta stock with a strike price of $25. What does the market price of Delta have to be for Lew to break-even on his option investment? Ignore transaction costs and taxes. A) $22 B) $25 C) $28 D) cannot be determined from the information provided

C) $28

Allison bought 100 shares of MIKO, Inc. stock at a price of $35 a share. In addition, she bought a 35 put on MIKO at a cost of $125. Which of the following are true about Allison's position from now until the option expiration date? I. Her maximum loss is $3,625. II. Her maximum loss is $125. III. Her minimum gain is $125. IV. Her maximum profit is unlimited. A) I and IV only B) II and III only C) II and IV only D) II, III and IV only

C) II and IV only

LEAPS are a special type of option... A) that must be exercised within six months. B) that can only be exercised on the expiration date. C) that cannot be exercised for at least a year after it is is purchased. D) that may have an expiration date as long as three years.

D

LEAPS is an acronym for... A) Lehman and Ellsworth Authority Strips. B) Liability & Equity Asset Securities. C) LYONS Earnings Anticipation Stocks. D) Long-Term Equity Anticipation Securities.

D

Which of the following affect the value of puts and calls written on shares of common stock? I. price volatility of the underlying stock II. current market price of the underlying stock III. length of time until the option expiration date IV. current market interest rate A) I and II only B) I, II and III only C) II, III and IV only D) I, II, III and IV

D

Which one of the following statements concerning options is correct? A) One option covers 1,000 shares of stock. B) A put gives the option holder the right to buy a stated amount of securities. C) The owner of a call is entitled to the dividends paid on the underlying shares of stock. D) Option holders can profit on movements of the price of the underlying security.

D

Writers of option contracts... A) have a limited liability specified in the contract. B) hope to exercise the option on favorable terms. C) earn a commission no matter what subsequently happens to the contract. D) earn a profit when the option expires without being exercised.

D

In late November, Karen bought FIB February puts with a strike price of $25. The ask price of the put was $281. The current price of FIB shares is $28.40. The intrinsic value of the put is... A) $340. B) $(340). C) $(621). D) $0.00.

D) $0.00.

What is the intrinsic value of a call with a strike price of $40 a market price of $44? The call's ask price $540... A) -$400 B) -$140 C) $940 D) $400

D) $400

Which one of the following was the first listed exchange for stock options in the United States? A) Stock Index Board B) Philadelphia Board of Trade C) New York Stock Exchange D) Chicago Board Options Exchange

D) Chicago Board Options Exchange

A listed option's ask price is always higher than its bid price.

False

A naked option is a conservative investment with limited risk.

False

A put option has a strike price of $32. The current price of the stock is $34. The put option is said to be "in-the-money"

False

American style options can only be exercised on their expiration dates.

False

An options strike price is the stock price at which the option holder breaks even.

False

Covered call writers have unlimited loss exposure as well as unlimited profit potential.

False

If a stock price does not rise or fall by the amount of the option premium, the option will not be exercised.

False

Investors buy options at the bid price and sell at the ask price.

False

It is riskier to buy an option than to write an option.

False

Listed options are difficult to sell in the secondary market.

False

Options premiums tend to be smaller as the time to expiration increases.

False

Puts and calls are issued by the same corporation that issued the underlying stock.

False

Rights and warrants are the riskiest types of options.

False

Standardized options expire on the last business day of the expiration month.

False

The buyer of a call option has the right to any dividends paid after the option was purchased, but only if the option is exercised.

False

The buyer of a put expects the price of the underlying stock to rise.

False

The longer the time to expiration, the lower the option time premium tends to be.

False

The owner of a put is obliged to sell the underlying security at the strike price on the date of expiration.

False

The party that accepts the legal obligation to stand behind the option is the buyer of the contract.

False

The prices of puts and calls on the same stock move independently of one another.

False

Warrants are short-term options usually expiring within a year or less.

False

An option straddle is the simultaneous purchase (or sale) of both a put and a call option on the same underlying security.

True

Technically, listed options expire on the Saturday following the third Friday of the expiration month.

True

The buyer of a put and the writer of a call both profit if the price of the stock falls.

True

The price behavior of the underlying security is the primary determinant of the price of an option.

True

The value of a call increases as the price of the underlying security rises.

True

The writer of a call option is theoretically exposed to an unlimited loss.

True

Warrants are options, often attached to bond issues ,to make the bonds more attractive to investors.

True

Writing covered calls may result in a profit to the writer even if the stock price does not change.

True