Series 7 Chapter 4

An investor with no other positions sells 1 ABC Jun 25 put at 1.50. If the put is exercised when the stock is trading at 24 and the investor immediately sells the stock in the market, what is the investor's profit or loss? A) $150 loss. B) $50 profit. C) $50 loss. D) $150 profit.

Your answer, $50 profit., was correct!. The investor has the obligation to buy the stock at the strike price of 25. The stock is currently worth 24, which is a loss of 1. The investor's premium of 1.50 minus the loss of 1 leaves a net profit of .50 (.50 × 100 = $50).

Automatic exercise will occur for equity options at expiration that are in-the-money by at least: A) 1/8 of a point. B) 1/4 of a point. C) 0.05. D) 0.01.

Your answer, 1/4 of a point., was incorrect. The correct answer was: 0.01. Automatic exercise will occur for equity options at expiration that are in-the-money by at least .01, unless specific instructions are given by the customer not to do so.

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) 2300. B) 200. C) 1800. D) 700.

Your answer, 1800., was correct!. 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.

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) 275. C) 225. D) 300.

Your answer, 250., was incorrect. The correct answer was: 300. 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.

If the Swiss franc closes at 56, 1 SF 59 put is: A) 3 points in-the-money. B) 3 points out-of-the-money. C) at the money. D) without intrinsic value.

Your answer, 3 points in-the-money., was correct!. The put is in-the-money when the underlying instrument's market price is below the put's strike price.

A customer buys 10 DEC 91.50 calls on the Canadian dollar for 6.70. ($10,000 CD per contract). At the time of purchase, the spot rate for the Canadian dollar was 92.25. What is the margin requirement for the purchase? A) 6700. B) 3350. C) 9150. D) 9225.

Your answer, 3350., was incorrect. The correct answer was: 6700. The client purchased 10 calls at 6.70 for a total of $6,700. The margin requirement is 100% of the premium.

If a customer writes 1 ABC Nov 60 put at 3.50, and the put is exercised when ABC is 57.50, the customer' s cost basis in ABC stock is: A) 60. B) 57.5. C) 56.5. D) 54.

Your answer, 56.5., was correct!. At exercise, the premium of the contract affects the cost basis of the stock acquired. Because the premium of 3.50 was received when the put was written, the cost basis of the stock will be $60 per share less the premium, or 56.50.

If a writer of an XYZ equity call option is assigned, which of the following should be delivered to the OCC? A) The underlying XYZ security B) Rights or warrants exercisable to purchase the underlying XYZ security C) Any listed security of comparable value to XYZ D) Cash equal to the market value of the underlying XYZ security

Your answer, Any listed security of comparable value to XYZ, was incorrect. The correct answer was: The underlying XYZ security When a call is exercised, that specific security must be delivered by the assigned writer. The option contract does not allow for exercise settlement in cash, securities of equivalent value, or securities exercisable to purchase the underlying securities such as rights or warrants.

Which of the following strategies would most effectively protect an investor with a short stock position? A) Sell a call. B) Buy a put. C) Buy a call. D) Sell a put.

Your answer, Buy a call., was correct!. Purchasing a call on the security protects the customer from a loss in excess of the strike price plus the cost of the call should the security rise in price.

A Japanese manufacturer sells recorders to a U.S. retailing firm. The manufacturer is to receive $1 million (U.S. dollars) in 90 days. How can he best protect himself against a decline in the dollar? A) Sell yen puts. B) Buy yen puts. C) Sell yen calls. D) Buy yen calls.

Your answer, Buy yen calls., was correct!. Because he is receiving U.S. dollars, his risk is that the U.S. dollar will go down in value against the Japanese yen. If the dollar goes down against the yen, the yen will rise. Therefore, to protect his risk against a rising yen, he should buy yen calls. The yen calls will increase in value if the yen rises.

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) Premium of 5. B) Exercise price of 70. C) Contract size of 100 shares. D) Expiration date in April.

Your answer, Contract size of 100 shares., was incorrect. The correct answer was: Premium of 5. 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.

The holder of a yield-based call option would be more likely to profit if rates rise rates fall debt prices rise debt prices fall. A) II and III. B) I and IV. C) I and III. D) II and IV.

Your answer, I and III., was incorrect. The correct answer was: I and IV. Holders of yield-based call options profit if rates rise. Prices of debt securities fall if rates rise.

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

Your answer, I and IV, was correct!. 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.

If your client writes a combination of a DWQ 45 call and a DWQ 50 put and the premiums total $650, he breaks even when the price of the underlying stock is $43.50 $50.50 $51.50 $56.50 A) II and IV. B) I and III. C) I and IV. D) III and IV.

Your answer, I and IV., was incorrect. The correct answer was: I and III. Combinations and straddles have two breakeven points. To calculate these breakeven points add the combined premiums to the call strike price and subtract the combined premiums from the put strike price.

Which of the following options positions would reduce the risk on a long position in the underlying stock? Buy a put. Buy a call. Sell a call. Sell a put. A) I and IV. B) II and III. C) I and II. D) I and III.

Your answer, II and III., was incorrect. The correct answer was: I and III. Buying a put reduces risk on the stock's decline. Selling a call reduces the net cost of the long purchase. Both are hedging the stock position.

A client writes 1 Jan 60 put and buys 1 Jan 50 put. This is a bull spread. bear spread. debit spread. credit spread. A) I and III. B) II and III. C) II and IV. D) I and IV.

Your answer, II and III., was incorrect. The correct answer was: I and IV. This is a put credit spread, and bulls sell puts. The 60 put is worth more because it has a higher strike price. Long the lower put is bullish; short the lower put is bearish.

A customer, long 100 shares of ABC at 73, writes 1 ABC Apr 75 call at 2 to generate additional income. ABC stock subsequently moves higher at which time the customer is exercised. For tax purposes, which of the following statements are TRUE? Cost basis is $73 per share. Cost basis is $71 per share. Sales proceeds are $75 per share. Sales proceeds are $77 per share. A) I and III. B) I and IV. C) II and IV. D) II and III.

Your answer, II and IV., was incorrect. The correct answer was: I and IV. If a covered call writer is exercised, cost basis (for tax purposes) is the cost of stock purchased. Sales proceeds are adjusted (strike price plus premium) to reflect the premium received.

In a volatile market, which of the following option strategies carries the most risk? A) Long straddle. B) Short straddle. C) Debit spread. D) Credit spread.

Your answer, Long straddle., was incorrect. The correct answer was: Short straddle. To establish a short straddle, the investor sells a call and a put; the short call carries unlimited loss potential.

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

Your answer, Premium., was incorrect. The correct answer was: Strike price minus premium. The maximum loss on a naked put is equal to the breakeven (strike price minus premium for puts). The maximum loss is breakeven multiplied by the number of shares covered by the contracts.

If an investor purchases 500 shares of an aggressive growth stock, which strategy would limit his downside risk? A) Writing 5 puts on the stock. B) Writing 5 straddles. C) Buying 5 calls on the stock. D) Buying 5 puts on the stock.

Your answer, Writing 5 straddles., was incorrect. The correct answer was: Buying 5 puts on the stock. A put gives the investor the right to sell stock at a set price (the strike price) for a period of time, and protects against losses below the strike price. Buying calls can protect a short stock position. If the customer is long stock, the purchase of calls on that security increases leverage and risk. Writing a put creates the obligation to buy more stock at the strike price, which increases downside risk.

A registered representative makes the following comment to his client, "Writing options is a good way to increase your income on this stock." Which of the following should be included with this comment? A) You may lose future profits and risk of loss is still possible. B) You will gain the option premium, with no chance of loss. C) Your stock covers the option, so you cannot lose. D) There is no other possible hedge on a long stock position.

Your answer, You will gain the option premium, with no chance of loss., was incorrect. The correct answer was: You may lose future profits and risk of loss is still possible. Because the registered representative is recommending covered call writing, he should also explain the risks involved.

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

Your answer, day following the third Friday of the month, was incorrect. The correct answer was: last day of trading Yield-based options expire like stock options; on the third Friday of the expiration month which is the last day of trading.

All of the following are call buyers' objectives EXCEPT: A) speculating for profit on the rise in price of stock. B) delaying a decision to buy stock. C) diversifying holdings. D) hedging a long stock position against falling prices.

Your answer, delaying a decision to buy stock., was incorrect. The correct answer was: hedging a long stock position against falling prices. Long stock positions are best hedged with the purchase of a long put. Call buyers protect short stock positions, speculate on the upward movement of a stock's price, diversify their holdings, and delay the decision to buy stock because of the expiration period.

An investor who buys a stock and wishes to limit the potential downside risk should: A) buy a call. B) buy a put. C) enter a buy stop order. D) enter a sell limit order.

Your answer, enter a buy stop order., was incorrect. The correct answer was: buy a put. The purchase of a put limits the downside risk to the difference between the stock price and the put's strike price.

On exercise of the option, the holder of a put will realize a profit if the price of the underlying stock: A) exceeds the exercise price plus the premium paid. B) falls below the exercise price minus the premium paid. C) falls below the exercise price. D) exceeds the exercise price.

Your answer, falls below the exercise price., was incorrect. The correct answer was: falls below the exercise price minus the premium paid. Breakeven for the buyer of a put is the strike price of the option minus the premium paid for the option.

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

Your answer, have a longer life than other listed options., was incorrect. The correct answer was: are available only on index options. LEAPS are available on both individual stocks as well as indexes.

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.

Your answer, improve the return on a portfolio., was correct!. 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.

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

Your answer, premiums determined by participants., was incorrect. The correct answer was: active secondary trading. Unlike listed options, unlisted options do not trade continuously in an organized secondary market; trades are negotiated between individuals.

The writer of an IRX yield based option, if exercised, must: A) receive T-notes. B) deliver cash. C) receive cash. D) deliver T-bills.

Your answer, receive cash., was incorrect. The correct answer was: deliver cash. Yield based options settle in cash if the option is exercised. The writer must deliver the in-the-money amount in cash.

At expiration, if the market price of the underlying common stock and the strike price are the same, each of the following customer positions will show a profit EXCEPT: A) short calls. B) long straddles. C) short straddles. D) short puts.

Your answer, short puts., was incorrect. The correct answer was: long straddles. The contracts will not be exercised if options expire at the money. Therefore, writers will show a profit but buyers will not.