OPTIONS QUIZ MISSES
A customer sells short 100 shares of DEF stock at $62 and sells 1 DEF Oct 60 Put @ $6. The maximum potential gain while both positions are in place is: A. $800 B. $4,400 C. $5,400 D. unlimited
The best answer is A. If the market drops, the short put is exercised and the customer must buy the stock at $60. Since the stock was sold at $62, the customer gains 2 points, in addition to collecting 6 points of premiums. Thus, the maximum gain is $800. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.
A customer sells 1 ABC Jul 40 Put at $6 when the market price of ABC is $38. The customer's maximum potential gain is: A. $600 B. $3,400 C. $4,000 D. unlimited
The best answer is A. The maximum gain for the writer of a naked call or put is the premium collected. This happens if the contract expires "out the money."
What will cover the sale of 1 ABC Jan 50 Put? A. Buy 100 shares of ABC stock @ $50 B. Short 100 shares of ABC stock @ $50 C. Long 1 ABC Jan 50 Call D. Short 1 ABC Jan 50 Call
The best answer is B. If the short put is exercised, the writer must stand ready to buy 100 shares of ABC stock at $50. The put will be exercised if the market drops. If the customer sells short 100 shares of ABC stock at 50, then any loss on the short put will be offset by an equal gain on the short stock position, "covering" the short put from loss if exercised. Being long 100 shares of ABC stock does not cover the short put because if the market drops, the customer will now lose on the long stock position as the market drops, in addition to losing on the short put. The long call does not cover the short put because if the market drops, the long call expires and the fixed premium is lost. A short call does not cover the short put because if the market drops, the short call expires and the fixed premium is earned, but this does not compensate for the fact that if the market keeps on dropping, the loss on the short put goes higher and higher.
The writer of a put on a listed stock is exercised. Upon assignment, the writer must: A. pay the premium B. deliver cash C. buy stock D. sell stock
The best answer is C. If the writer of a put option on listed stocks is exercised, he or she must buy 100 shares of stock, for which the writer will pay the strike price in cash.
A customer owning 100 shares of stock could receive protection by: A. buying another 100 shares of the stock B. buying a call C. buying a put D. selling a put
The best answer is C. In order to hedge a long stock position against a downside market move, the best choice is to buy a put. The long put option allows the holder to put (sell) the stock at the exercise price if the market falls - protecting the stock position from downside market risk.
Which statement is TRUE about index option contracts? A. They are custom OTC contracts where the terms are negotiated between buyer and seller B. They are available in either American or European style C. Exercise settlement is in cash D. Trade settlement is the same day
The best answer is C. Index option contracts, such as the SPX (Standard and Poor's 500 Index Option) allow an investor to bet on broader market movements, as opposed to individual stock price movements. They are standardized options contracts that are exchange traded. They are also useful to institutions that wish to hedge their portfolios, or that wish to generate extra income against their portfolios. They are more "potent" than individual stock options, because the value of the S&P 500 Index is so high (around 2,700), so in theory 1 contract covers 100 x 2,700 = $270,000 worth of stock. So, in theory, for an institution that wishes to hedge a portfolio, fewer contracts need to be purchased (lower cost hedging). Unlike stock options, index options are generally issued European style (exercise can only occur at expiration, not before). Exercise settlement is in cash, unlike stock options where exercise settlement results in a delivery of stock. Like stock options, index options can be traded anytime, and trade settlement is next business day for both.
A customer buys 100 shares of ABC stock at $40 and buys 1 ABC Oct 40 Put @ $4. The breakeven point is: A. $36 B. $40 C. $44 D. $48
The best answer is C. The customer paid $4 for the put and $40 for the stock, for a total of $44. To breakeven, she must sell the stock at $44. To summarize, the formula for breakeven for a long stock / long put position is = stock price + premium
A customer sells short 100 shares of ABC stock at $38 and buys 1 ABC Mar 40 Call @ $5. The maximum potential loss is: A. $200 B. $500 C. $700 D. unlimited
The best answer is C. The long call limits loss on the short stock position in a rising market. The stock was sold for $38 and can be bought back at $40 by exercising the call. The loss is $2 per share on the stock position. Since $5 per share was paid in premiums, the total loss is 7 points or $700.
Long the stock and short the call is an appropriate strategy in a: A. declining market B. rising market C. stable market D. fluctuating market
The best answer is C. Whenever a customer has a stock position, and the customer wishes to generate extra income by selling an option against that position, the market sentiment is neutral. This is a covered call writer - a call writer who owns the underlying stock position. The customer sells the call contract to generate extra income from the stock during periods when the market is expected to be stable. If the customer expects the market to rise, he or she would not write the call against the stock position because the stock will be "called away" in a rising market. If the customer expects the market to fall, he or she would sell the stock or buy a put as a hedge.
A customer is long an ABC Jan 60 Call. The position has a profit that the customer wishes to capture. The proper order to enter is a(n): A. opening purchase B. closing purchase C. opening sale D. closing sale
The best answer is D. All options orders must be marked either "opening" or "closing." The OCC maintains the record of all listed options contracts. Opening positions are recorded on the books of the OCC; while orders to close positions remove them from the books of the OCC. Note that a customer can open by selling an option contract and will close by purchasing that option contract; or the customer can open by purchasing an option contract and will close by selling that option contract.
A client buys an ABC Jul 50 Call @$2 when the stock is trading at $55. The contract: A. is out of the money B. has 2 points of intrinsic value C. has 3 points of intrinsic value D. has 5 points of intrinsic value
The best answer is D. In the money and out the money amounts for options contracts disregard the premium amount. The holder of this call has the right to buy ABC stock at $50 per share when the market price of ABC is at $55, so the contract is 5 points "in the money" - meaning there is a 5 point profit at this moment to the holder, disregarding the premium paid. If the question asked "What is the profit or loss?" then the answer would be a 3 point profit because 2 points were paid in premiums.
