Options 1 (3rd)

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:

0.8225. 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).

The term that describes options of the same exercise price and expiration date for the same underlying security is: A) type. B) issue. C) class. D) series.

D) series. Options at the same exercise price and expiration date for the same underlying security are known as a series of options.

An investor wants to purchase TCB stock (currently trading at 38), and he expects the price of TCB stock to decline in the short term before rising. If he wants to purchase the stock below its current market value and generate additional income, he could: A) write a call at 35. B) buy a put and exercise the option. C) buy a 40 call and exercise the option. D) write a put at 35.

D) write a put at 35. If the investor writes a put, he collects a premium. If the stock price rises, the put expires worthless and the investor keeps the premium. However, if the stock price declines as the customer anticipates, the put will force the customer to buy stock at 35. The effective cost of the stock is the breakeven point (strike price minus the premium).

Options are known as _________________ securities because they derive their value from that of the underlying security.

derivative

In a straddle the options are treated ______________ for tax purposes.

separately

Buying a put option on a security he holds allows an investor to 1) participate in additional gains if the security continues to increase in price. 2) buy more stock if he exercises the put. 3) protect a profit on his current stock position. 4) receive the premium for the purchase of the put.

1) participate in additional gains if the security continues to increase in price. 3) protect a profit on his current stock position. Purchasing a put allows the stockholder to lock in a sale price. If the price continued to rise, the investor would not exercise the put. He would let it expire and sell the stock at the higher market price thus continuing to participate in the additional gains. If the stock fell the investor would exercise the right to sell the stock at the strike price and in this way protects a gain on the stock. Remember that options buyers pay the premium, they do not receive it, and exercising a put gives one the right to sell the stock, not buy it.

An investor establishes the following position: Long 1 XYZ Jan 50 put at 2 What is the maximum potential gain on the position?

4800. The maximum gain is calculated by subtracting the premium from the strike price (50 − 2 = 48 per share). One contract represents 100 shares, so the buyer's maximum gain is $4,800 (this occurs if the stock becomes worthless).

Index options settle ___________.

in cash the next business day.

If a customer writes 10 DEF Aug 50 calls at 1 when DEF is trading at 44, what is the maximum gain?

1000. When writing options, the maximum gain is equal to the premium received. Because there are 10 calls with a premium of $100 each, the maximum gain is 10 multiplied by $100, or $1,000.

A customer writes 3 XYZ Sep 55 puts at 5 when the stock is trading at 53.50. How much aggregate time value do these contracts have?

1050. Puts are in-the-money (have intrinsic value) when the market price of the underlying stock is below the strike price. In this case, the contracts are in the money by 1.50. Therefore, the time value of each contract is 3.50 or $350 per contract. As there are 3 contracts, the aggregate time value is $1,050. time value = premium - intrinsic value

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?

11. 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.

At expiration, if the market price of the underlying stock is the same as the strike price, which of the following positions would be profitable? 1) Short call 2) Long straddle 3) Long call 4) Short put

1) Short call 4) Short put Writers of option contracts are profitable if an option expires worthless because they keep the premiums received. If the strike price and the market price are the same at expiration, an option contract will not be exercised by the contract owner (buyer). This leaves the writer with the premiums received when the contract expires and thus profitable by that amount.

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? 1) The gain is $250. 2) The gain is $400. 3) For tax purposes, cost basis per share is 62.50. 4) For tax purposes, cost basis per share is 61.

2) The gain is $400. 3) For tax purposes, cost basis per share is 62.50. 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 assigned or closing the position, writers of puts might be required to 1) sell the underlying stock. 2) buy the underlying stock. 3) sell the outstanding put. 4) buy the outstanding put.

2) buy the underlying stock. 4) buy the outstanding put. 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.

A customer buys 1 XYZ Jan 65 put at 3.50 when XYZ is trading at 63.10. Just prior to expiration, with the option trading at 6.65 bid-6.70 asked, the customer closes his position with a market order. The gain is what?

315 The gain or loss is the difference between the price paid for buying the option, which is $350, and the price received for selling the option, which is $665. This equals $315. Remember, you buy at the asked price and sell to the bid.

A customer buys 2 ABC Feb 20 puts at 2 when ABC is trading at 19. If the contracts are closed at 4 when ABC is trading at 17, the customer has a: A) $400 gain. B) $200 gain. C) $200 loss. D) $400 loss.

A) $400 gain. When closing an option, a gain or loss is the difference between premiums paid and premiums received. The customer bought two contracts at $200 each ($400 cost) and sold both contracts at $400 each ($800 sale). The gain is $400.

Which of the following would not be a factor in determining the price of an options contract? A) The listing exchange B) The time remaining to expiration C) The volatility of the underlying stock D) The price of the underlying stock

A) The listing exchange Time remaining, volatility of the underlying stock, and price of the underlying stock all affect the price of an option contract. The exchange where the contract is listed should not impact pricing.

All of the following are true about LEAPS EXCEPT they: A) are available only on index options. B) may be exercised at any time after execution. C) cease trading at 4:00 pm ET. D) have a longer life than other listed options.

A) are available only on index options. LEAPS are available on both individual stocks as well as indexes.

The time value of an option that is at-the-money equals: A) its premium. B) its intrinsic value. C) it's intrinsic value less premium. D) zero.

A) its premium. The option has no intrinsic value if the strike price equals the market price (at the money). The only value an option has is its time value, which equals the premium.

A __________ receipt for the stock will cover a short call .

An escrow receipt for the stock.

What is the size of one LEAPS contract? A) More than 1,000 shares. B) 100 shares. C) 1,000 shares. D) There is no standard LEAPS contract size.

B) 100 shares. Like a standard options contract, the size of a LEAPs contract is 100 shares.

A customer buys 10 ABC Jul 25 calls at 4.50. What is the total premium paid for the position? A) 450. B) 4500. C) 29500. D) 20500.

B) 4500. A premium of 4.50 multiplied by 100 shares per contract, multiplied by 10 contracts equals $4,500.

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

B) Long puts. The premium paid to acquire the option represents the most an investor stands to lose on a long option position. "Covered" and "uncovered" are terms that relate to short option positions.

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

B) The time value is zero. An option's premium consists of time value and intrinsic value. In this situation, the call is in-the-money by 5 (intrinsic value is 5), because the market value of 40 exceeds the strike price of 35 by 5. If the total premium is 5 and the intrinsic value is 5, the time value must be 0. The option is at parity, which means the premium equals the intrinsic value.

Compared with selling short, buying a put option: A) has a lower loss potential. B) all of these. C) requires a smaller capital commitment. D) does not require meeting the locate requirement for short sales.

B) all of these. Buying a put requires a smaller capital commitment than does shorting the stock and has a lower loss potential (the premium only) because selling short involves unlimited risk. When selling stock short on an exchange, the shares to be borrowed must be located before the sale. This is not a requirement when buying a put.

A customer writes 1 ABC July 60 put at 3 when ABC is at 61. ABC subsequently declines to 54 and the option is exercised. If the customer later sells his long stock position at 58, the customer has a: A) loss of $100. B) gain of $100. C) loss of $400. D) gain of $400.

B) gain of $100. The investor receives $300 for writing the put, then pays $60 per share to acquire the stock when the put is exercised, giving him a cost basis of $5,700. Because the stock is later sold for $58, the investor ends up with an overall gain of $100 ($5,800 - $5,700).

An investor with no other positions sells 4 DWQ Jun 45 calls at 4. The calls are exercised when the stock is trading at 47.25. What is the investor's profit or loss? A) $175 profit. B) $175 loss. C) $700 profit. D) $700 loss.

C) $700 profit. When the calls were exercised, the investor had the obligation to sell the stock to the owner of the call at 45. Because the investor had no other positions we know that in order to fulfill the obligation to sell they will first need to purchase the stock in the open market for 47.25. 4 was received when the call was sold and 45 was received when the stock was sold to the owner of the call. Therefore a total of 49 was received. 47.25 had to be paid to purchase the stock in the open market. Therefore 47.25 paid and 49 received = 1.75 point profit ($175) per contract. $175 × 4 contracts = $700 total profit.

If a customer writes one uncovered in-the-money put, the maximum gain would be: A) unlimited. B) the strike price plus the premium multiplied by 100 shares. C) 100% of the premium. D) the strike price minus the premium multiplied by 100 shares.

C) 100% of the premium. The maximum gain to an option writer is the premium received.

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 is at the money. B) The option's time value equals its intrinsic value. C) The option is at parity. D) The option is out-of-the-money.

C) The option is at parity. 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 strategies would be considered most risky in a bull market? A) Buying a put. B) Writing naked puts. C) Writing naked calls. D) Buying calls.

C) Writing naked calls. Writing naked calls provides unlimited liability and the most risk. Buying a call would be an attractive strategy in a bull market with risk limited to calls paid. Writing naked puts risks only the difference between the strike price and zero, less any premium received. Buying a put is a bearish strategy with risk limited to the amount paid for the put.

A customer buys 1 XYZ Dec 30 call at 7 and sells 1 XYZ Dec 40 call at 1. Two months later, if the customer closes the positions when the spread is trading at 9 points, the customer has A) a loss of $100 B) a gain of $100 C) a gain of $300 D) a loss of $300

C) a gain of $300. The investor established a debit spread and paid a net premium of $600 (7 − 1). The spread widened to 9, giving the investor a profit of $300 (9 − 6). Debit spreads are profitable if the spread between the premiums widens.

A customer sells 6 ABC calls for total premiums of $750. One month later, the customer closes his position when the contract is trading at 3 and the result is a: A) gain of $450. B) loss of $450. C) loss of $1,050. D) gain of $1,050.

C) loss of $1,050. This customer opens his position with a credit of $750 to his account. He closes his position with a debit of $300 per contract multiplied by 6 contracts, or $1,800. The result is a loss of $1,050.

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) $200 loss. C) $600 gain. D) $600 loss.

D) $600 loss. 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.

Which of the following option strategies besides going long a call can be used to purchase stock below its current market value? A) Long put. B) Short call. C) Short straddle. D) Short put.

D) Short put. If the put is exercised by the owner the writer of the put will be obligated to purchase the stock. The cost of the stock is reduced by the amount of premium taken in when the put was written allowing the investor to purchase the stock at a net cost lower than the stock's current market value.

If a March 80 Canadian dollar call option is trading at 6 and the Canadian dollar is at $.85, which of the following statements is TRUE? A) The contract is at parity. B) The contract is out-of-the-money. C) The contract has no time value. D) The contract has intrinsic value.

D) The contract has intrinsic value. A call is in-the-money whenever the market value of the underlying instrument is above the strike price. The Canadian dollar is currently at $.85 (85 cents) which is above the strike price of $.80 (80 cents), so this call is in-the-money and therefore has intrinsic value of .05 (5 cents). This contract is trading .01 greater than the intrinsic value of .05. Therefore, it also has a time value of .01 (1 cent).

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

D) a corporation against its own stock. Corporations are not permitted to write calls against their own stock. If exercised, they would have to issue shares at the strike price, and this would have a dilutive effect on shareholders.

A covered call could be written to: A) lock in a profit. B) purchase future securities. C) protect a short stock position. D) improve the return on a portfolio.

D) improve the return on a portfolio. Writing a call will not necessarily lock in the profit. In the form of increased cash flow, it will improve the return on the portfolio.

Individuals with diversified stock holdings in their portfolios write covered calls to: A) increase the number of shares they own. B) benefit from share price increases. C) lock in profits. D) increase their rate of return on the stocks held in their portfolio.

D) increase their rate of return on the stocks held in their portfolio. Covered call writing is frequently used by persons who own the underlying stock to increase rate of return. If the options expire unexercised, the writer keeps the premium, which provides additional portfolio income.

As the underlying stock price increases, the premium of a call option generally: A) remains the same. B) fluctuates. C) decreases. D) increases

D) increases The premium of an option changes as the market price of the underlying security moves; therefore, if the stock price increases, the premium of a call also increases.

In March, a customer sells 1 ABC Oct 50 put for 3 and buys 1 ABC Oct 60 put for 11. The customer will experience a pretax profit from these positions if: I. the difference between the premiums narrows to less than $8 II. the difference between the premiums widens to more than $8 III. both puts are exercised at the same time IV. both puts expire unexercised.

II. the difference between the premiums widens to more than $8 III. both puts are exercised at the same time This debit spread becomes profitable if the spread widens between the premiums. Credit spreads are profitable if the spread narrows between the premiums. If both puts are exercised, the spread is profitable. If the short 50 put is exercised, the customer buys the stock and sells it for 60 by exercising the long 60 put ($1,000 profit − $800 premiums = net $200 profit).

If a customer buys 500 shares of ABC at 48 and writes 5 ABC 50 calls at 2, what is the maximum loss?

The investor pays $48 per share for the stock and receives $2 for selling the calls. The maximum loss is $48 per share minus the option premium collected, or ($48 − $2) × 500 shares = $23,000.

Time value

The time value is the premium minus the intrinsic value.

Weekly contracts

Weekly contracts or "weeklies" tend to have lower premiums than other types of contracts due to the short period of time between when they are issued and when they expire (1 week). They can be traded anytime during their week-long life cycle, expire on Fridays, and are issued each week of the month except the week that standardized contracts would be expiring.

If a put or call on a stock expires unexercised, the amount a writer receives is __________________________.

a short-term capital gain