Options Straddles
A customer buys 5 ABC Jan 30 Straddles for a total premium of $3,500. Just prior to expiration ABC stock closes at $21, and the customer closes the options positions at intrinsic value. The customer will have a: Correct A. $1,000 gain StatusB B. $1,000 loss StatusC C. $3,500 gain StatusD D. $3,500 loss
The best answer is A. A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. In this case the customer: Buys 5 ABC Jan 30 Calls Buys 5 ABC Jan 30 Puts $700 Debit x 5 contracts = $3,500 Debit Note that the individual premiums are not given in the question, nor are they needed to answer the question. If the market drops below $30, the call will expire "out the money" and the put goes "in the money." Here the put is "in the money" (or has intrinsic value of) 9 points. This results in a 9 point profit on the put, if it is "closed" (sold) at intrinsic value. But, since 7 points were paid in premiums, the customer has a net gain of 2 points per share, or $200 per contract. Since there are 5 contracts, the total gain is $1,000.
If the market price of the underlying security is greater than the strike price of the option contract, which of the following is likely to have a profit? I The buyer of a straddle II The seller of a straddle III The seller of a call Correct A. I only StatusB B. II only StatusC C. III only StatusD D. II and III
The best answer is A. If the market price is greater than the strike price of the option contract, the buyer of an "at the money straddle" can exercise the call contract profitably (a long straddle consists of a call and a put on the same stock, with the same strike price and expiration). The put contract side of the straddle would expire "out the money." If the market price stays the same, the buyer will lose, since both the call and the put that create the straddle would expire "at the money." Concerning Choices II and III, both of these positions have a naked short call, which gives the writer unlimited upside risk. If the market price rises above the strike price, the calls go "in the money" and are exercised. This obligates the call writer to deliver stock at a fixed price; and this stock must now be purchased for delivery in the market at a higher price (and the market price can rise an unlimited amount!)
A customer's portfolio consists of the following positions: Market Value Cost Basis 10,000 ABCC $500,000 $300,000 10,000 DEFF $300,000 $500,000 10,000 PDQQ $500,000 $500,000 Both the registered representative and the customer believe that while the investments are appropriate for the customer, the market will remain "flat" for the next 3 months. The following options with 3 month expirations are available: ABCC Jan 50 Calls @ $4 ABCC Jan 50 Puts @ $3 DEFF Jan 30 Calls @ $2 DEFF Jan 30 Puts @ $6 PDQQ Jan 50 Calls @ $1 PDQQ Jan 50 Puts @ $1 If the customer wishes to maximize income with minimum risk, and only wants to trade 100 contracts, the best recommendation for the customer is to: A. Sell 100 ABCC Jan 50 Calls B. Sell 100 DEFF Jan 30 Puts C. Sell 100 ABCC Jan 50 Calls and 100 PDQQ Jan 50 Puts D. Sell 100 PDQQ Jan 50 Calls and 100 DEFF Jan 30 Puts
The best answer is A. Since this customer owns stock, he or she can derive extra income by selling covered calls against the stock positions. To maximize income, the calls with the highest premiums should be sold - and the ABCC premium of $4 is the highest of the 3 call contracts shown. As long as the market stays flat, the calls will expire and the customer will earn the premium income, If the market rises, the stock will be called away. Since he bought the stock for $30 per share; and the call strike is at $50, if the stock is "called away," the customer will make $20 on the stock, plus will also earn the $4 premium per share. If the stock drops, the calls expire, but it can fall a long ways before the customer loses money (remember, the customer bought the stock at $30 and it is now worth $50). The sale of puts is not consistent with the customer's objective of minimizing risk. If the customer sells puts and the market drops, the customer not only loses on underlying stock position, but the short puts will be exercised, obligating the customer to buy the stock at the strike price - creating a "doubled up" loss in a falling market.
A customer sells 1 ABC Jan 30 Call @ $5 and sells 1 ABC Jan 30 Put @ $4 on the same day when the market price of ABC stock is $31. Assume that the market price rises to $38 and the call premium rises to $12, while the put premium falls to $1. The customer closes the positions. The gain or loss is: Correct A. $400 loss StatusB B. $400 gain StatusC C. $900 gain StatusD D. $1,300 loss
The best answer is A. The customer established two positions with a credit of $9 x 1 contract = $900 credit. When the market is at $38, the customer closes the call at $12 and closes the put at $1. Thus, the positions are closed at: Buy 1 ABC Jan 30 Call @ $12 Buy 1 ABC Jan 30 Put @ $ 1 $13 debit = $1,300 debit The customer closed for a debit of $1,300. Since the initial credit was $900, the customer has a $400 loss.
On the same day when the market price of ABC is $48, a customer: Buys 1 ABC Jan 50 Call @ $3 Buys 1 ABC Jan 50 Put @ $5 The breakeven points are: I $42 II $45 III $53 IV $58 StatusA A. I and III Correct B. I and IV StatusC C. II and III StatusD D. II and IV
The best answer is B. The buyer of the straddle paid 8 points in premiums. The holder has to recover the 8 points to breakeven. This happens if the market rises by that amount; or falls by that amount. So, the customer will break even when the market is at $42 (for the Put side of the straddle, since the put is "in the money" by 8 points; the call expires "out the money") and $58 (for the Call side of the straddle since the call is "in the money" by 8 points; the put expires "out the money"). To summarize, the breakeven formulas for a long straddle are Call =B/E = Strike +Prem Put=B/E= Strike+Prem
A customer sells 5 ABC Jan 60 Calls @ $4 and sells 5 ABC Jan 60 Puts @ $1 on the same day when the market price of ABC stock is $62. The customer's maximum potential gain is: A. $500 B. $2,500 C. $25,000 D. unlimited
The best answer is B. The positions created by the customer are: Short 5 ABC Jan 60 Calls @ $4 Short 5 ABC Jan 60 Puts @ $1 $5 credit x 5 contracts = $2,500 credit If the market stays exactly at $60, both the calls and puts expire "at the money" and the customer gains $2,500. If the market rises, the calls go "in the money" and the puts expire. The customer has unlimited loss potential on the calls. Conversely, if the market drops, the puts go "in the money" and the calls expire. The maximum potential loss on the downside is the strike price of the put (60) less the credit of 5 = $55 per share x 500 shares = $27,500 loss.
A customer buys 1 ABC Jan 45 Call @ $7 and buys 1 ABC Jan 45 Put @ $3 on the same day when the market price of ABC stock is $49. Assume that the market price falls to $44 and the call premium falls to $5, while the put premium rises to $7. The customer closes the positions. The customer has a: A. $100 gain B. $200 gain C. $1,000 gain D. $1,200 loss
The best answer is B. The customer established two positions with a debit of $10 x 1 contract = $1,000 debit. When the market is at $44, the customer closes the call at $5 and closes the put at $7. Thus, the positions are closed at: Short 1 ABC Jan 45 Call @ $ 5 Short 1 ABC Jan 45 Put @ $ 7 $12 credit = $1,200 credit The customer closed for a credit of $1,200. Since the initial positions cost $1,000, the customer has a $200 gain.
A customer sells 1 ABC Jan 55 Call @ $4 and 1 ABC Jan 65 Put @ $7 when the market price of ABC is at $58. ABC goes to $62 and the customer closes the positions at intrinsic value. The customer has a: A. $100 loss B. $100 gain C. $1,100 loss D. $1,100 gain
The best answer is B. The customer has sold a combination. Sell 1 ABC Jan 55 Call @ $ 4 Sell 1 ABC Jan 65 Put @ $ 7 $11 Credit If the market moves up to $62, the 65 Put is 3 points "in the money" while the 55 Call is 7 points "in the money." Closing the contracts at these premiums results in: Buy 1 ABC Jan 55 Call @ $7 =*($62-$55MKprice )* Buy 1 ABC Jan 65 Put @ $ 3 =*($65-$62MKprice )* $10 Debit The net profit is: $11 Credit - $10 Debit = $1 or $100 on the positions
A customer *buys* 1 ABC Jul 55 Call @ $2 and 1 ABC Jul 60 Put @ $5 on the same day. Just prior to expiration, the stock is trading at $59 and the customer closes the positions at intrinsic value. The customer has a net loss of: A. $50 B. $100 C. $200 D. $700
The best answer is C. The customer has purchased a long combination, for combined premiums of $700. When the stock is at $59, the long 60 put is *($60-$59)*=1 point "in the money," resulting in a 1 point gain to the holder while the long 55 call is *($59-$55)*=4 points "in the money," resulting in a 4 point gain to the holder. $700 paid in premiums minus a *(5point +1point)* $500 profit = $200 loss.
Which of the following positions creates a "strangle" if the market price of ABC stock is $52 per share? I Buy 1 ABC Jan 55 Call II Buy 1 ABC Jan 50 Call III Buy 1 ABC Jan 55 Put IV Buy 1 ABC Jan 50 Put A. I and II B. III and IV C. I and III D. I and IV
The best answer is D. A "strangle" is a specific variation of a combination, where both contracts are "out the money." A long strangle is the purchase of an "out the money" call and an "out the money" put. Only Choice D fits this definition. Buy 1 ABC Jan 55 Call Buy 1 ABC Jan 50 Put This would be done when the market price is between $50 and $55. Both contracts are "out the money" and the premiums paid would be lower than if a long straddle was purchased. To profit, the price must move up sharply above $55 by at least the amount of premiums paid; or must move down sharply below $50 by at least the amount of premiums paid. This is a volatility strategy, similar to a long straddle.
A customer sells 1 ABC Jul 30 Call @ $1 and sells 1 ABC Jul 30 Put @ $3.50 when the market price of ABC is $29. The maximum potential loss is: A. $450 B. $2,550 C. $3,450 D. unlimited
The best answer is D. Since one side of a short straddle is a *short naked call*, if the market rises there is unlimited risk The best answer is D. Since one side of a short straddle is a short naked call, if the market rises there is unlimited risk
Which TWO choices are "combinations"? I Long 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Call II Long 1 ABC Jan 60 Put; Short 1 ABC Jan 50 Put III Long 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put IV Short 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Put A. I and II B. III and IV C. I and IV D. II and III
The best answer is B. A "straddle" is the purchase of a call and put; or the sale of a call and put; with the same strike prices and expirations. A "combination" is the same as a straddle, except that the strike prices and/or expirations are different.