Options

An investor with no other positions sells 1 ABC Dec 55 call at 4.50. If the call is exercised when the stock is trading at 57.25, what is the investor's profit or loss? A) $225 profit. B) $275 loss. C) $225 loss. D) $275 profit.

A) $225 profit. Explanation When the call is exercised, the investor is forced to buy the stock in the market for 57.25 and sell it to the owner of the call for 55, for a 2.25-point loss. The investor's premium of 4.50 minus the loss of 2.25 gives the investor a profit of 2.25 (2.25 × 100 = $225). If a call is exercised, a writer must sell (deliver) his shares at the strike price.

On January 1, an investor buys 1 FLB Apr 50 call at 4 and 1 FLB Apr 50 put at 2.50. If both options expire unexercised, what are the tax consequences for the investor? A) $400 loss on the call, $250 loss on the put. B) $150 net capital gain. C) $400 gain on the call, $250 gain on the put. D) $150 net capital loss.

A) $400 loss on the call, $250 loss on the put. Explanation In a straddle the options are treated separately for tax purposes. The investor has a $400 capital loss on the call and a $250 capital loss on the put. Both are short-term losses.

Your client purchased 100 shares of ULA common stock at $40 per share 2 years ago. Today, the client buys one ULA Apr 60 put at $2, when the stock's price is $65. At expiration, the ULA stock is selling for $56, and the client exercises his put, delivering the long stock to cover the sale. The client has a gain of: A) 1800. B) 2300. C) 700. D) 200.

A) 1800. Explanation Exercise of the put enables the client to sell the stock at the strike price of $60. The stock was originally purchased at $40, so the result is a $2,000 gain in the stock minus the $200 premium paid for the put, for a net gain of $1,800.

If a customer buys 100 XYZ at 49 and writes 1 XYZ Nov 50 call, receiving $350 in premiums, the breakeven point is: A) 45.5. B) 53.5. C) 52.5. D) 46.5.

A) 45.5. Explanation This is a covered call, so the investor is protected against declining stock prices to the extent of the premium received, and the breakeven is 45.50 (49 − 3.50).

Which of the following has the least amount of risks? I. Long a call in a rising market. II. Long a put in a falling market. III. Short a call in a rising market. IV. Short a put in a falling market. A) I and II. B) I and IV. C) II and III. D) III and IV.

A) I and II.

At expiration, the market price of the underlying stock is the same as the strike price of the option. Which of the following positions result in a profit? I. Short call II. Long call III. Short put IV. Long put A) I and III B) I and IV C) II and III D) II and IV

A) I and III Explanation The option has no intrinsic value if the market price of the underlying stock is equal to the strike price of an option (put or call). If an option has no intrinsic value at expiration, it is theoretically worthless. If an option expires worthless, the writer profits.

If assigned or closing the position, writers of puts might be required to I. sell the underlying stock. II. buy the underlying stock. III. sell the outstanding put. IV. buy the outstanding put. A) II and IV. B) I and IV. C) II and III. D) I and III.

A) II and IV.

If assigned or closing the position, writers of puts might be required to I. sell the underlying stock. II. buy the underlying stock. III. sell the outstanding put. IV. buy the outstanding put. A) II and IV. B) II and III. C) I and IV. D) I and III.

A) II and IV. Explanation If you write a put, you are selling the option to someone else. You are giving them the right to sell the underlying stock to you at the strike price during the term of the option. To close that position, you have to buy back the same option you sold or, if assigned, buy the stock.

Mr. Jones calls his registered representative and places an order to write an XYZ Oct 90 call and at the same time to write an XYZ Oct 80 put. The orders are executed at a premium of 5 for the call and 9 for the put. Which of the following best describes the customer's investment strategy? A) Neutral strategy. B) Bearish strategy. C) Bullish strategy. D) Mixed strategy.

A) Neutral strategy. Explanation A customer who writes both a call and a put on the same underlying security wishes for little or no market movement. This is referred to as a neutral strategy. Technically, the customer has created a short combination (an investment position very similar to a short straddle, with the same investment characteristics), and, in this case, a little less risk than a pure straddle because of the spread in the strike prices.

Listed options on U.S. exchanges are available on all of the following currencies EXCEPT the: A) U.S. dollar. B) Euro. C) Japanese yen. D) Canadian dollar.

A) U.S. dollar.

All of the following accounts are permitted to write calls EXCEPT: A) a corporation against its own stock. B) a custodian in an UTMA account against a long-stock position. C) a mutual fund against a long stock position. D) an individual in a margin account

A) a corporation against its own stock.

Due to an escalating trade war, the portfolio manager of an equity mutual fund anticipates a negative impact on his fund's assets. To protect his investment portfolio, the fund manager would: A) buy S&P 500 index puts. B) buy S&P 500 index calls. C) sell S&P 500 index calls. D) sell S&P 500 index puts.

A) buy S&P 500 index puts.

Yield-based options expire on the A) last day of trading B) day following the third Friday of the month C) third Wednesday of the month D) day after the last day of trading

A) last day of trading

A customer buys 200 XYZ at 32, 2 XYZ June 35 calls at 3 and 1 XYZ June 35 put at 6.50. Two months later, the customer purchases 1 XYZ June 35 put at 4. Before expiration, with XYZ trading at 37, he sells his stock, and closes his calls at 2.10 and his puts at .25 for a: A) loss of $180. B) gain of $180. C) loss of $450. D) gain of $450.

A) loss of $180. Explanation The customer opens 4 positions with debits to his account: 200 shares at $32 per share = a debit of $6,400; 2 calls at $300 each = $600; 1 put at $650 = a debit of 650; and finally, an additional put at $400. The stock position is sold for $37 per share for a credit of $7,400. The calls are closed for 2.10 each, a credit of $420, and the puts are closed for a credit of $25 each.

A customer buys 1 XYZ Aug 50 put at 1 and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58. If XYZ is at 52 at expiration, the customer has a: A) loss of $400. B) gain of $400. C) loss of $600. D) gain of $600.

A) loss of $400. Explanation The 50 put expires because it is out of the money. The customer closes the position in the 65 put by purchasing it for its intrinsic value, $1,300. Because the account was credited $900 when the spread was established, there is a $400 loss ($1,300 − $900). Alternately, breakeven is 56 (65 − 9) and the spread is bullish. Therefore, the customer makes money above 56 and loses below 56. Because the stock is at 52 at expiration, the customer has a $400 loss (56 to 52).

For a customer who has purchased stock and wants to write a call option, the option ticket would be marked: A) opening sale. B) closing sale. C) closing purchase. D) opening purchase.

A) opening sale. Explanation An opening transaction is used when establishing a new option position. It is an opening purchase if your client is buying the option. It is an opening sale if your client is writing the option. "Closing" is the term used when the client eliminates an existing option position through a trade of the contract.

The derivative-based strategy known as portfolio insurance involves the: A) purchase of a put on the underlying security position. B) purchase of a call on the underlying security position. C) sale of a call on the underlying security position. D) sale of a put on the underlying security position.

A) purchase of a put on the underlying security position. Explanation The purchase of a put option to hedge the downside risk of an underlying security holding is called a protective put position one of many derivative-based strategies collectively known as portfolio insurance.

The manager of a portfolio that consists predominately of large- and mid-cap stocks could hedge against a market downturn and generate additional income by A) selling broad index calls. B) selling broad index puts. C) buying broad index calls. D) buying broad index puts.

A) selling broad index calls.

An investor with no other positions sells 1 DEF Jan 95 put at 5.50. If the put is exercised when the stock is trading at 79 and the investor immediately sells the stock in the market, what is the investor's profit or loss? A) $550 loss. B) $1,050 loss. C) $550 profit. D) $1,050 profit.

B) $1,050 loss. Explanation The investor has the obligation to buy the stock for 95 while the stock is currently worth 79, for a loss of 16. The loss of 16 minus the 5.50 premium received gives the customer a loss of 10.50 (10.50 × 100 = $1,050).

A client bought 100 XYZ at $65 per share and sold an XYZ 65 call at 8. Closing the short call at 10 and selling XYZ at 68 would result in a: A) $100 loss. B) $100 profit. C) $500 loss. D) $500 profit.

B) $100 profit. Explanation The client made $300 on the stock and lost $200 on the option for a $100 profit.

In early September, a customer buys 100 shares of QRS stock for $83 per share and simultaneously writes 1 QRS Mar 90 call for $4 per share. If the QRS Mar 90 call were exercised and the QRS stock delivered, what would be the customer's per share profit? A) 4. B) 11. C) 7. D) 0.

B) 11. Explanation If the stock rises above $90, the writer will be exercised and make $700 on the stock (buy at $83, deliver at $90) and keep the $400 received in premiums. Alternatively, the breakeven point is 79 (83 − 4), and the stock was sold (delivered) at 90 for an 11-point gain.

An ABC 40 call is quoted at 4.25 - 4.50 and an ABC 45 call is quoted at 1.50 - 2.00. What is the cost of establishing a debit spread? A) 225. B) 300. C) 275. D) 250.

B) 300. Explanation To establish a debit spread, an investor buys a 40 call at the ask price of 4.50, and sells a 45 call at the bid price of 1.50. The net premium paid is (4.50 less 1.50) × 100 shares which equals $300.

An ABC 40 call is quoted at 4.25 - 4.50 and an ABC 45 call is quoted at 1.50 - 2.00. What is the cost of establishing a debit spread? A) 250. B) 300. C) 225. D) 275.

B) 300. Explanation To establish a debit spread, an investor buys a 40 call at the ask price of 4.50, and sells a 45 call at the bid price of 1.50. The net premium paid is (4.50 less 1.50) × 100 shares which equals $300.

IBM sold computers to a Soho retailer and agreed to accept payment of 10 million British pounds in 65 days. In which of the following ways could the company protect the payment against adverse foreign currency fluctuations? A) Buy U.S. dollar puts and/or sell U.S. dollar calls. B) Buy pound puts and/or sell pound calls. C) Buy U.S. dollar calls and/or sell U.S. dollar puts. D) Buy pound calls and/or sell pound puts.

B) Buy pound puts and/or sell pound calls. Explanation If the company wants to protect its investment, it has to protect against the payment going down in value relative to the cost. To protect against the value of the payment going down in relation to the cost, the company would buy puts on the payment currency. To offset the cost of the puts, the company will also sell calls. The calls will be covered by the ownership of the actual currency.

An investor owns 100 shares of IBM. Which of the following would make a long hedge? A) Writing a put. B) Buying a put on IBM. C) Buying a call on IBM. D) Writing a call.

B) Buying a put on IBM. Explanation If you own the stock, you want the market value to rise. To hedge the position against a decrease in value, you would buy a put option.

In which of the following strategies would the investor want the spread to widen? I. Buy 1 RST May 30 put; write 1 RST May 25 put. II. Write 1 RST Apr 45 put; buy 1 RST Apr 55 put. III. Buy 1 RST Nov 65 put; write 1 RST Nov 75 put. IV. Buy 1 RST Jan 40 call; write 1 RST Jan 30 call. A) I and IV. B) I and II. C) II and III. D) III and IV.

B) I and II.

A customer buys 1 LMB Aug 70 put for 4 and 1 LMB Aug 70 call for 4. If the price of LMB stock is $70, at what prices would the customer break even? I. $62. II. $66. III. $74. IV. $78. A) I or IV. B) I or III. C) II or IV. D) II or III.

B) I or IV. Explanation To break even, the customer must recover $800 paid in premiums. On the long 70 call, this occurs if the market price rises to 78. On the long 70 put, this occurs if the market price falls to 62.

Which of the following statements regarding the exercise of options contracts are TRUE? I. The exercise of equity options settles the next business day. II. The exercise of equity options settles in 3 business days. III. The exercise of index options settles next business day. IV. The exercise of index options settles in 3 business days. A) I and III. B) II and III. C) I and IV. D) II and IV.

B) II and III.

A customer writes 1 ABC Jan 65 put at 6 and 1 ABC Jan 55 call at 7 when ABC is trading at 60. This position will be profitable if, at expiration, ABC is I. above 68 II. at 60 III. below 52 IV. between 52 and 68 A) I and III. B) II and IV. C) I and II. D) II and III.

B) II and IV. Explanation This is a short combination where both contracts are in-the-money. Short combinations are like short straddles, except the strike prices and/or the expirations are different. The breakeven points are computed by adding the combined premiums to the strike price of the call (strike price + premium) and subtracting the combined premiums from the strike price of the put (strike price − premium). The breakeven points, therefore, are 52 (65 − 13) and 68 (55 + 13). With a short combination, the investor makes money if the stock stays inside the breakeven points.

A customer writes 1 ABC Jan 65 put at 6 and 1 ABC Jan 55 call at 7 when ABC is trading at 60. This position will be profitable if, at expiration, ABC is I. above 68 II. at 60 III. below 52 IV. between 52 and 68 A) II and III. B) II and IV. C) I and III. D) I and II.

B) II and IV. Explanation This is a short combination where both contracts are in-the-money. Short combinations are like short straddles, except the strike prices and/or the expirations are different. The breakeven points are computed by adding the combined premiums to the strike price of the call (strike price + premium) and subtracting the combined premiums from the strike price of the put (strike price − premium). The breakeven points, therefore, are 52 (65 − 13) and 68 (55 + 13). With a short combination, the investor makes money if the stock stays inside the breakeven points.

If an investor buys 1 DWQ Apr 70 call at 5, giving him the right to buy 100 shares of DWQ at $70 per share, which aspect of the transaction is NOT set or standardized by the OCC? A) Contract size of 100 shares. B) Premium of 5. C) Expiration date in April. D) Exercise price of 70

B) Premium of 5. Explanation The OCC sets standard exercise prices and expiration dates for all listed options, but the options premiums that buyers pay are determined by the market.

An investor long 100 shares of stock writes a call against the long stock position. If the call is exercised and the investor must deliver the stock, which of the following tax consequences will occur? A) Cost basis is adjusted for the stock. B) Sales proceeds are adjusted for the stock. C) There are no adjustments for cost basis or sales proceeds for tax purposes. D) Both cost basis and sales proceeds must be adjusted.

B) Sales proceeds are adjusted for the stock. Explanation When the call is exercised the owner of the stock will be obligated to sell the shares owned at the strike price. The sales proceeds for the stock will be adjusted upwards by the amount of the premium received when the call was sold.

A customer who owns a portfolio of blue-chip stocks believes the securities will provide long-term appreciation, but fears that the market will decline over the short term. Which index options strategy should protect against the expected decline and allow the customer to generate additional income? A) Buy puts. B) Sell covered calls. C) Sell covered puts. D) Buy calls.

B) Sell covered calls.

What is the maximum potential loss for a naked put option? A) Unlimited. B) Strike price minus premium. C) Premium. D) Strike price plus premium.

B) Strike price minus premium.

A gain on the sale of a long equity put option is: A) always a long-term capital gain. B) always a short-term capital gain. C) ordinary income. D) a short- or long-term capital gain.

B) always a short-term capital gain.

If an American exporter will be paid 25 million Japanese yen when her goods arrive in 45 days, her best hedge is to: A) sell yen puts. B) buy yen puts. C) sell yen calls. D) buy yen calls.

B) buy yen puts. Explanation The exporter does not want to see the value of the yen fall. If she owns yen puts and the yen does fall, her profit on the puts would help compensate for the decrease in the value of the yen. Selling yen calls would also provide protection if the yen fell in value, but only to the extent of the premium received. Exporters buy puts in order to hedge; importers buy calls on the foreign currency to hedge.

If your customer owns 100 shares of a volatile stock and wants to limit downside risk, you may recommend: A) buying calls. B) buying puts. C) shorting the same stock. D) writing calls and selling puts.

B) buying puts. Explanation Downside risk is reduced by purchasing a put with a strike price at or close to the stock's purchase price. Should the stock decline below the strike price, the investor can exercise the put at the strike price. Selling put options will increase the downside risk. Buying calls is a bullish strategy that increases downside risk. Shorting stock will lock in the current price but will limit upside potential.

Buying back an option contract that was previously written or selling an option contract that was previously purchased is known as: A) dollar-cost averaging. B) closing out a position. C) indexing. D) exercising.

B) closing out a position. Explanation When an investor sells a security they are long or buys back a security they are short, they are closing out an existing position.

A customer buys 1 XYZ Aug 60 call at 4 and 1 XYZ Aug 60 put at 2 when XYZ is at 61.25. If the stock rises to 68 and the customer lets the put expire and closes out the call at intrinsic value, the result is a: A) loss of $200. B) gain of $200. C) loss of $600. D) gain of $600.

B) gain of $200. Explanation The customer has established a long straddle. To determine profit or loss, compute the breakeven points by both adding and subtracting the combined premiums (6 points) from strike (the breakeven points are 54 and 66). Because the customer profits if the stock moves outside these points, at 68, the customer has a 2-point ($200) gain.

In determining a violation of position limits, short calls are aggregated with: A) short puts. B) long puts. C) long calls. D) all of these.

B) long puts. Explanation Position limits are measured by the number of contracts on the same side of the market. Long calls and short puts are on the bull side; short calls and long puts are on the bear side.

An investor, long 100 shares of XYZ at 23.50, writes 1 XYZ May 25 call at 2. At expiration, if XYZ is trading at $20, the investor has a: A) gain of $50. B) loss of $150. C) gain of $150. D) loss of $50.

B) loss of $150. Explanation Breakeven is 21.50 (23.50 − 2). If the stock is trading at 20, the customer has an unrealized loss of $150.

A customer creates a long straddle by buying 5 ABC Nov 50 calls and 5 ABC Nov 50 puts paying premiums of $3,750. If ABC is at 56.50 at expiration, the customer has a: A) loss of $1,000. B) loss of $500. C) gain of $500. D) gain of $1,000.

B) loss of $500. Explanation While the puts would expire, the customer may close out the calls by selling them at 6.50 (56.50 − 50) for $3,250 (6.50 × 5 × $100). The result is a loss of $500 ($3,750 − $3,250).

The derivative-based strategy known as portfolio insurance involves the: A) sale of a put on the underlying security position. B) purchase of a put on the underlying security position. C) purchase of a call on the underlying security position. D) sale of a call on the underlying security position.

B) purchase of a put on the underlying security position.

On February 7, a customer buys 100 shares of LMN at $39 per share and simultaneously writes an LMN Oct 35 call option at 6. If the call is exercised on July 19, what will he report for tax purposes? A) $600 loss. B) $600 gain. C) $200 gain. D) $200 loss.

C) $200 gain. Explanation The premium received for writing a call becomes part of the stock sales proceeds for a total of $4,100. Because the investor bought the stock 5 months earlier for $3,900, he incurred a $200 capital gain (short-term).

An investor buys 2 LMN 40 calls and pays a premium of 4 each, and also buys two LMN 40 puts and pays a premium of 2.50 each. At the time of purchase, LMN is trading at $40.75. On the expiration date, LMN is trading at $32.50. If the investor closes his position for its intrinsic value. Excluding commissions, the investor realizes a: A) $100 loss. B) $200 loss. C) $200 profit. D) $100 profit.

C) $200 profit. Explanation Closing out a position is the opposite of the opening transaction. In this situation, the investor opened by buying 2 calls for a total of $800, and closed them out by selling for their intrinsic value (calls have intrinsic value when the market value is above the strike price; in this situation there is no intrinsic value). The investor also bought 2 puts for a total of $500 and closed them out by selling for their intrinsic value of $1,500 (puts have intrinsic value when the market value is below the strike price; in this situation the intrinsic value is $7.50 per contract) or 40 − 32.50 = 7.5 × 2 = 15 × 100 shares = $1,500). The resulting profit on the position is $200 ($1,500 − $1,300), the total of the premiums paid for all of the options.

If an investor writes 2 DWQ Jan. 60 puts at 3 in September and the investor buys back the 2 puts at 4.50 two months later, the result for tax purposes is a: A) $150 short-term capital gain. B) $150 short-term capital loss. C) $300 short-term capital loss. D) $300 short-term capital gain.

C) $300 short-term capital loss. Explanation A $900 closing cost minus $600 opening proceeds equals a $300 short-term loss.

An investor writes 1 TCB 320 put for 21.35 and the stock closes at 304.50. He makes a closing transaction at the intrinsic value and the result is a: A) $155 profit. B) $585 loss. C) $585 profit. D) $155 loss.

C) $585 profit. Explanation The investor opened the position and received 21.35 for selling the option. He closed the position by buying the option at its intrinsic value, which equals the difference between the stock's market price and the option's strike price. In this example, 320 - 304.50 equals an intrinsic value of 15.50. The investor's gain is the difference between the sale price of 21.35 and the purchase price of 15.50, which equals 5.85, or $5.85. His profit is $5.85 multiplied by 100, or $585.00.

If a customer buys 300 ABC at 53 and writes 3 ABC June 55 calls at 4, and the contracts expire unexercised the customer's cost basis in ABC stock at expiration is: A) 57. B) 49. C) 53. D) 51.

C) 53. Explanation The cost basis in the stock remains at the original purchase price. The premium received must be declared by the investor as a capital gain for tax purposes. Premiums on options will only affect the stock's cost basis or sales proceeds if the option is exercised, or if (on the same day) a customer buys stock and buys a put.

If the S&P 500 Index closed at 350 on the day your customer purchased a 355 put on the Index for $500, which of the following would best describe your customer's position? A) Out-of-the-money. B) Even money. C) Breakeven. D) At-the-money.

C) Breakeven. Explanation Remember that for a put option, subtract the premium from the strike price to find the breakeven point. 355 − 5 = 350. Since the S&P Index closed at 350 on the day, the customer's position is at breakeven.

Which of the following covers a short call? I. Long stock II. Short stock III. Long put IV. Stock rights A) I and III B) II and IV C) I and IV D) II and III

C) I and IV Explanation Covering a short call requires taking action to eliminate the risk of being exercised. If the customer owns the stock or has the right to acquire it, the customer is covered. Stock rights (preemptive rights) give the holder the right to purchase the stock. Short stock and long puts both have the same market attitude as a short call (bearish) and therefore would not cover the risk associated with a short call.

Having held 100 shares of GHI stock for 15 months, a customer purchases 1 GHI Jan 50 put in December. If the put is exercised before the expiration date and the long stock is delivered, which of the following statements are TRUE? I. The premium is added to the sale proceeds. II. The premium is deducted from the sale proceeds. III. Any gain is long-term. IV. Any gain is short-term. A) I and IV. B) II and IV. C) II and III. D) I and III.

C) II and III.

A taxable gain or loss on a long call option transaction would be recognized when I. the option is purchased. II. the option expires. III. the option is sold. IV. the option is exercised. A) I and IV. B) I and II. C) II and III. D) III and IV.

C) II and III. Explanation In addition to being exercised, call options can either be sold or allowed to simply expire. If either of these situations occurs, the owner of the call would determine his gain or loss (for tax purposes) at the time of expiration or sale. This would be determined by comparing what he paid for the call versus the price at which he sold the call. If it expires, the entire amount of the premium originally paid is considered a loss. Gains or losses are not determined at the time that calls are exercised. Once exercised, the underlying security must then be sold at the CMV. Then the owner of the call would calculate his profit or loss, taking into account the premium paid, what he paid for the stock, and what he subsequently sold the stock for

On which of the following positions does the potential loss equal the premium? A) Covered calls. B) Covered puts. C) Long puts. D) Uncovered puts.

C) Long puts.

With the same dollar amount either paid or received, which of the following strategies can cause an investor to experience the greatest loss? A) Buying a straddle. B) Selling a covered put option. C) Selling a naked call option. D) Selling a naked put option.

C) Selling a naked call option.

Which of the following listed option positions is most unsuitable for a customer whose investment objectives include minimal risk? A) Long call. B) Short put. C) Short call. D) Long put.

C) Short call.

If a registered representative wants to appear on a radio talk show to discuss various options strategies, which of the following statements is TRUE? A) No approval is required, provided the representative does not make any recommendation B) The appearance must be approved by FINRA. C) The appearance must be approved by the ROP designated by the firm to handle compliance and supervisory issues. D) The appearance must be approved by the branch manager.

C) The appearance must be approved by the ROP designated by the firm to handle compliance and supervisory issues.

All of the following actions must be completed prior to a customer entering his first option trade EXCEPT: A) delivery of an OCC Disclosure Booklet. B) approval by a sales supervisor. C) completion of the options agreement. D) completion of the new account form.

C) completion of the options agreement.

A customer buys 100 DEF at 70, but several months later, the stock is trading at 82.85. The customer, concerned about a possible pullback, buys 1 DEF Aug 80 put at 1.50. If the stock subsequently falls to 77.25 and the customer sells his stock by exercising the put, the result is: A) gain of $875. B) gain of $575. C) gain of $850. D) loss of $150.

C) gain of $850. Explanation The customer bought 100 shares at 70 and sold them at 80 by exercising the put for a gain of $1,000. However, it cost $150 to buy the put so the customer's gain is $850. In other words, breakeven for long stock-long put is the cost of stock purchased (70) plus the premium paid (1.50). Breakeven is 71.50 and the customer sold stock at 80 (80 − 71.50 = 8.50-point gain).

An option investor might do all of the following EXCEPT: A) make an opening sale. B) hedge a short stock position with a long call . C) hedge a long stock position with a short put. D) make a closing purchase.

C) hedge a long stock position with a short put. Explanation Writing a put does not reduce the risk of a long stock position. The short put creates an obligation to purchase additional shares if the put is exercised (which will happen if the stock falls). A long call is an effective hedge against a short stock position.

Covered put writing is a strategy where an investor: A) sells a put and sells a call on the same stock. B) sells a put on a stock that he owns. C) sells a put on a stock he has sold short. D) sells a put and buys a call on the same stock.

C) sells a put on a stock he has sold short.

Covered call writing normally occurs in a A) volatile market. B) falling market. C) stable market. D) rising market

C) stable market.

puts (in, out, at the money, breakeven)

CMV < SP = in the money CMV = SP = at the money CMV > SP = out of the money breakeven = SP - premium

calls (in, out, at the money, breakeven)

CMV > SP = in the money CMV = SP = at the money CMV < SP = out of the money breakeven = SP + premium

An investor with no other positions buys 1 DWQ May 75 call at 6.50. If the investor exercises the call when the stock is trading at 77 and immediately sells the stock in the market, what is the investor's profit or loss? A) $350 loss. B) $350 profit. C) $450 profit. D) $450 loss.

D) $450 loss. Explanation The investor exercised the right to buy the stock for 75 and can sell the stock in the market for 77, for a gain of 2. The investor paid a premium of 6.50 minus the gain of 2, which gives the investor a loss of 4.50 (4.50 × 100 = $450).

A customer sells 3 ABC Feb 25 puts at 4 when ABC is at 24. If the contracts are closed out at intrinsic value when ABC is at 19, the customer has a: A) $200 gain. B) $600 gain. C) $200 loss. D) $600 loss.

D) $600 loss. Explanation Because the investor sold the puts for a total of $1,200 to open his position, he must buy the options to close out his position. If he buys back the puts when ABC is at 19, the intrinsic value at that time is 6 because puts are in-the-money when the market price is below the strike price (25 − 19 = 6). He pays a total of $1,800 to close out his 3 contracts and, because he paid more than he received, incurs a loss of $600.

An investor buys a yield-based Sept 70 call on a 30-year T-bond for a premium of 2.50. At expiration, if the yield on the most recently issued T-bond is 7.95%, what is the investor's gain or loss? A) $950 gain. B) $700 loss. C) $950 loss. D) $700 gain.

D) $700 gain. Explanation A September 70 call means that the holder is buying a 7% yield. The investor can close the option at its intrinsic value: (7.95 − 7.00 = 0.95; 0.95 × 10 × $100 = $950 received upon close). Subtract $250 premium paid for a total profit of $700.

A foreign currency investor is long 40,000 Swiss francs at $.81. If the investor buys 4 July 80 SF puts at 1.25 to hedge, the breakeven point is: A) 0.5125. B) 0.4875. C) 0.4975. D) 0.8225.

D) 0.8225. Explanation When hedging with puts, the breakeven point is the cost of the underlying investment plus premium paid ($.81 cents plus $.0125 equals $.8225, or 82¼ cents).

A customer establishes the following positions: Buy 100 JMB at 28 Buy 1 JMB Dec 25 put at 2 What is the maximum potential loss? A) 3000. B) 200. C) 2800. D) 500.

D) 500. Explanation The investor loses money on the long stock position when the market value falls. With the purchase of the put, the investor can sell the stock for no less than the strike price, but also loses the premium. In this example, the investor loses a maximum of $3 on the stock (28 − 25) plus the premium of $2, for a total loss of $500 on 100 shares

If a customer buys 1 XYZ Aug 50 put at 1, and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58, what is the maximum risk? A) 1500. B) 100. C) 900. D) 600.

D) 600. Explanation This is a credit spread. The maximum loss is the difference between the strike prices and the net credit. In this example, the strike price difference is 15 (65 - 50) and the net premium is 9 (10 − 1) or 15 − 9 = 6 × $100 = $600 maximum loss. Maximum gain is the net credit of $900.

When must a new options customer-who has not yet traded options-receive the Options Clearing Corporation's current disclosure document? A) At or before the time the registered representative signs the customer approval form. B) No later than 15 days after the ROP signs the options customer approval form. C) Within 15 days of the ROP's approval of the customer's account for options trading. D) At or before the time the account receives approval for options trading.

D) At or before the time the account receives approval for options trading.

Which of the following affects the holding period of XYZ stock, a position that has been held for 6 months? I. Buying an in-the-money put II. Buy an out-of-the-money put III. Writing an in-the-money call IV. Writing an out-of-the-money call. A) I and IV. B) III and IV. C) II and III. D) I and II.

D) I and II. Explanation Buying a put (in or out-of-the-money) on a stock held short term (one year or less) stops the holding period until the put is disposed of.

Which of the following statements regarding index options are TRUE? I. Exercise is settled in cash. II. Exercise settlement value is based on the value of the index at the time exercise instructions are received. III. Exercise settlement value is based on the closing index value on the day exercise instructions are tendered. IV. Exercise settlement is regular way. A) I and II. B) II and III. C) II and IV. D) I and III.

D) I and III.

Which of the following transactions in the same security will affect the holding period of a security held for 12 months or less? I. Buy a put. II. Buy a call. III. Sell short. IV. Sell a put. A) II and IV. B) I and II. C) II and III. D) I and III.

D) I and III. Explanation The holding period of a capital asset is based on the amount of time the asset is held at risk. When there is no longer the possibility of a loss, there is no longer any risk. Buying a put or selling short effectively removes the risk from a transaction and destroys any short-term holding period. The short-term holding period will not become a long-term holding period for tax purposes, as long as the offsetting position (put or short) is maintained.

If LEAPS options positions are maintained for more than 12 months, which of the following statements are TRUE? I. The LEAPS writer's gains are taxed as short-term gains. II. The LEAPS writer's gains are taxed as long-term gains. III. The LEAPS buyer's gains are taxed as short-term gains. IV. The LEAPS buyer's gains are taxed as long-term gains. A) I and III. B) II and IV. C) II and III. D) I and IV.

D) I and IV.

Which of the following investors will purchase stock if an option is exercised? I. Owner of a call II. Owner of a put. III. Writer of a call. IV. Writer of a put. A) III and IV. B) I and II. C) II and III. D) I and IV.

D) I and IV.

A customer, long 100 shares of QRS at 62.50, writes 1 QRS Sep 65 call at 1.50. If the call is exercised, which two statements are TRUE? I. The gain is $250. II. The gain is $400. III. For tax purposes, cost basis per share is 62.50. IV. For tax purposes, cost basis per share is 61. A) II and IV. B) I and III. C) I and IV. D) II and III.

D) II and III. Explanation The customer has paid 62.50 for the stock and has received 1.50 for the call. If the Sep 65 call is exercised the customer will receive 65 for the sale of the stock. After exercise, total received is 66.50 (1.50 + 65). 66.50 received minus 62.50 paid equal's 4 points profit ($400). If a covered call writer is exercised, the cost basis for tax purposes is the purchase price of the stock. Sales proceeds for tax purposes are 66.50 per share (strike price plus premium).

If a customer writes 1 ABC 60 put at 5 when ABC is trading at 58, which of the following statements are TRUE? I. The time value of the option is 2 points. II. The time value of the option is 3 points. III. Breakeven is 65. IV. Breakeven is 55. A) I and III. B) I and IV. C) II and III. D) II and IV.

D) II and IV.

Which of the following entities guarantees a listed yield-based option? A) Broker/dealer. B) U.S. government. C) FRB. D) OCC.

D) OCC.

With the same dollar amount either paid or received, which of the following strategies can cause an investor to experience the greatest loss? A) Selling a covered put option. B) Selling a naked put option. C) Buying a straddle. D) Selling a naked call option.

D) Selling a naked call option.

When XYZ stock trades at 40 and an XYZ Oct 35 call trades at 5, which of the following statements is TRUE? A) The option's time value equals its intrinsic value. B) The option is at the money. C) The option is out-of-the-money. D) The option is at parity.

D) The option is at parity. Explanation An option is at parity when its premium equals its intrinsic value. A call option has intrinsic value when the stock is trading above the call's strike price. In this example, the stock is at 40 and the call's strike price is 35, so the option is in the money by 5 points. The option is said to be trading at parity and there is no time value because the option's premium is 5.

Which of the following securities underlies a yield-based option? A) Revenue bonds. B) Debentures. C) Income bonds. D) Treasury securities.

D) Treasury securities.

A customer wishes to close a short option position. The order ticket must be marked as: A) a closing sale. B) an opening sale. C) an opening purchase. D) a closing purchase.

D) a closing purchase.

An investor owning an option contract liquidates the position. The liquidation is A) a closing purchase. B) an opening sale. C) an opening purchase. D) a closing sale.

D) a closing sale.

All of the following are characteristics of unlisted options EXCEPT: A) premiums determined by participants. B) negotiated exercise prices. C) negotiated expiration dates. D) active secondary trading.

D) active secondary trading.

An investor would sell a put: A) as an inflation hedge. B) because he is bearish. C) as a substitute for a short sale. D) because he is bullish.

D) because he is bullish.

The breakeven point for covered call writers is: A) cost of stock plus premiums . B) strike price plus premiums. C) strike price less premiums. D) cost of stock less premiums

D) cost of stock less premiums

Call-buying strategies include all of the following EXCEPT A) protection of a profit on a short sale of stock B) an increase in leverage with limited risk C) acquisition of a stock position D) covering a long stock position

D) covering a long stock position Explanation Long stock and long calls have the same market attitude: bullish. Therefore, covering a long stock position can not be accomplished by buying calls. The remaining answer selections are all strategies that could warrant call buying: increased leverage, acquisition of stock, and hedging a short stock position.

The manager of a portfolio that consists predominately of large- and mid-cap stocks could hedge against a market downturn and generate additional income by A) buying broad index puts. B) buying broad index calls. C) selling broad index puts. D) selling broad index calls.

D) selling broad index calls. Explanation The only way to generate income through the use of options is to sell them. If one is concerned that the market may fall, selling calls is the appropriate strategy.

If a customer who is long stock writes out-of-the-money calls against the position, and the calls subsequently expire worthless, for tax purposes the customer has a A) long-term gain. B) short-term loss. C) long-term loss. D) short-term gain.

D) short-term gain. Explanation If short calls expire worthless, the gain (for tax purposes) is considered a short-term capital gain.

put spreads

long the higher XP (debit) = bearish short the higher XP (credit) = bullish

call spreads

long the lower XP (debit) = bullish short the lower XP (credit) = bearish