Series 7- Options

A customer buys 2 ABC Jan 15 Puts @ 2 when the market price of ABC is $14. If the contracts are closed out at a premium of $4 when ABC stock is at $12, the gain or loss is: A. $200 gain B. $200 loss C. $400 gain D. $400 loss

$400 gain

A customer sells 10 ABC Jan 50 Calls @ 4.75 when the market price of ABC is $51 per share. The market price of the stock falls to $45 per share and the customer closes the contract at a premium of .50. The customer has a: A. $4,250 gain B. $4,750 gain C. $9,250 gain D. $9,750 gain

A. $4,250 gain

A customer buys 10 ABC Jan 50 Calls @ 4.75 when the market price of ABC is $51 per share. The maximum loss potential is: A. $4,750 B. $45,125 C. $50,000 D. unlimited

A. $4,750

A customer sells short 100 shares of ABC stock at $40 and buys 1 ABC Mar 40 Call @ $5. The maximum potential loss is: A. $500 B. $3,500 C. $4,500 D. unlimited

A. $500 (The long call limits loss on the short stock position in a rising market. The stock was sold for $40 and can be bought back at $40 by exercising the call. The only loss to the customer is the premium paid of 5 points or $500.)

A customer buys 200 shares of GE at 72 and sells 2 GE Jun 70 Calls @ $6. The maximum potential gain is: A. $800 B. $1,200 C. $7,000 D. unlimited

A. $800 (If the market rises, the calls are exercised. The stock (which cost $72) must be delivered at $70 for a loss of $2 per share. Since $6 was collected in premiums for selling the call, the net gain, if exercised, is 4 points or $400 per contract x 2 contracts = $800.)

A customer has a large portfolio of diversified blue chip stocks and would like to increase the income from the investments. Which of the following strategies are suitable? A. Covered call writing B. Naked call writing C. Covered put writing D. Naked put writing

A. Covered call writing (Covered call writing is suitable for securities that are expected to remain relatively constant in price. If the price remains constant, the calls expire and the premium is earned, with no gain or loss on the stock position. Blue chip stocks are less volatile than lesser quality stocks and are good candidates for covered call writing strategies. If covered calls are sold against these stocks, there is no margin required on the sale of the call. Downside risk is limited to the loss of the investment net of premiums received. Naked call writing exposes the writer to unlimited risk and is not suitable. Put writing strategies are used to increase income against short stock positions.)

The purchase of a put has which of the following advantages over selling a security short? I Lower capital requirement II No requirement to make up dividend payments on the borrowed shares III No loss of time value as the position is held A. I and II B. II and III C. III only D. I, II, III

A. I and II - Lower capital requirement & No requirement to make up dividend payments on the borrowed shares

Which statements are TRUE about option contracts? I Long puts go "out the money" when the market price rises above the strike price II Long puts go "out the money" when the market price falls below the strike price III Short puts go "out the money" when the market price rises above the strike price IV Short puts go "out the money" when the market price falls below the strike price A. I and III B. I and IV C. II and III D. II and IV

A. I and III (Always in the eyes of the holder of the contract)

Which of the following options strategies provides the greatest profit potential in a bull market? A. Long Call B. Short Call C. Long Put D. Short Put

A. Long Call (The purchaser of a call (long call) has the right to buy stock at a fixed price, no matter how high the market price of the stock may go. This strategy has unlimited gain potential.)

A customer would sell put contracts because the customer: A. is bullish on the underlying security B. is bearish on the underlying security C. wishes to generate ordinary income D. wishes to defer taxation of gains on the underlying stock

A. is bullish on the underlying security

To establish a long call position, an order ticket must be marked: A. opening purchase B. opening sale C. closing purchase D. closing sale

A. opening purchase

The "cost" of an option contract is the: A. premium B. exercise price C. market price of the underlying security D. intrinsic value

A. premium

An option contract that has not yet expired is one that has: A. time value B. intrinsic value C. present value D. cash value

A. time value

A customer sells 1 ABC Feb 50 Put @ $7 when the market price of ABC is $49. If the stock goes to $41 and just prior to expiration, the customer closes out the position with a closing purchase at intrinsic value, the gain or loss is: A. $200 gain B. $200 loss C. $700 gain D. $900 loss

B. $200 loss (The CUSTOMER established the short put position with an opening sale at +$7. He closes the position with a closing purchase at -$9 (intrinsic value when the put strike price is $50 and the market price is $41). The net loss is +$7 - $9 = -$2 per share or a $200 loss for the contract.)

A customer buys 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

B. $3,400

A customer sells short 100 shares of ABC stock at $41 and buys 1 ABC Mar 40 Call @ $5. The maximum potential gain is: A. $3,500 B. $3,600 C. $4,100 D. $4,600

B. $3,600 ( If the stock falls, the customer gains on the short stock position. The customer sold the stock for $41. If it falls to "0," the customer can buy the shares for "nothing" to replace the borrowed shares sold and make 41 points. The customer lets the call expire "out the money" losing 5 points, so the maximum potential gain is 36 points = $3,600. )

What is the "time premium" of the following contract? 1 ABC Jan 55 Put @ $9 ABC Market Price = $49 A. $0 B. $3 C. $6 D. $9

B. $3. (Time premium is any premium paid above the intrinsic value of the contract. In this case, the holder of the put can sell the stock at the strike price of $55 when the market price is $49, for a $6 profit to the holder. This is the "intrinsic value" of the contract. Since the total premium paid is $9, the time premium is $3.)

Which of the following are TRUE about debit price spreads? I Debit call spreads are bullish II Debit call spreads are bearish III Debit put spreads are bullish IV Debit put spreads are bearish A. I and III B. I and IV C. II and III D. II and IV

B. I and IV - Debit call spreads are bullish & Debit put spreads are bearish (To be profitable, debit spreads must be closed at a higher premium than paid (the spread between the premiums must widen; or both contracts must be exercised). This occurs when the market rises for calls; and when the market falls for puts.)

Which statements are TRUE? I Trades of foreign currencies take place on the Philadelphia Stock Exchange II Trades of foreign currency options take place on the Philadelphia Stock Exchange III Trades of foreign currencies take place in the interbank market IV Trades of foreign currency options take place in the interbank market A. I and III B. I and IV C. II and III D. II and IV

C. II and III (Trading of foreign currency options in the United States takes place on the Philadelphia Stock Exchange. The trading of foreign currencies takes place over-the-counter in the "interbank" market.)

The holder of a call on a listed stock exercises. The holder must: I deliver stock II deliver cash III take delivery of stock IV take delivery of cash

C. II and III- Deliver cash & take delivery of stock

If an equity call holder exercises a contract, the holder must deliver: A. cash in 1 business day B. stock in 1 business day C. cash in 2 business days D. stock in 2 business days

C. cash in 2 business days

To liquidate 1 ABC Jan 70 Short Put position, an order ticket must be marked: A. opening purchase B. opening sale C. closing purchase D. closing sale

C. closing purchase

If the market price is above the strike price on a put contract, the difference is termed the: A. in the money amount B. at the money amount C. out the money amount D. time value amount

C. out the money amount

The maximum gain for the holder of a put is: A. the premium paid B. unlimited C. strike price minus premium paid D. strike price plus premium paid

C. strike price minus premium paid

The breakeven point for the writer of a put is: A. the premium received B. unlimited C. strike price minus premium received D. strike price plus premium received

C. strike price minus premium received

The sale of an "at the money" call is a: A. bull strategy B. bear strategy C. neutral strategy D. bear/neutral strategy

D. bear/neutral strategy (The best answer is D. The seller of a call has the obligation to deliver stock at a fixed price in a rising market, in return for which the writer collects a premium. If the market stays the same, or falls, the call expires and the writer keeps the collected premium. This is a bear/neutral market strategy.)

To liquidate 1 ABC Jan 30 Long Call position, the order ticket must be marked: A. opening purchase B. opening sale C. closing purchase D. closing sale

D. closing sale

A mutual fund manager of a "high technology" fund wishes to hedge the portfolio against a market decline. The best strategy is to buy: A. broad-based calls B. broad-based puts C. narrow-based calls D. narrow-based puts

D. narrow-based puts (A "high-technology" fund could be hedged against loss by the purchase of index put contracts. A narrow-based index of high technology stocks would have a beta that more closely matches the fund's characteristics than a broad-based index (such as the OEX or XMI, which are principally composed of blue-chip stocks).)

The sale of a call has all of the same characteristics as selling stock short EXCEPT: A. unlimited loss potential in a rising market B. limited gain potential in a falling market C. low liquidity risk if the position is to be liquidated D. no erosion of value as the position is held

D. no erosion of value as the position is held . (The sale of a call has unlimited loss potential, as does the short sale of stock. The maximum gain for a call writer is the premium collected; the maximum gain on a short stock position occurs if the market falls to "0" and the position can be closed for nothing - so gain potential is limited for both. Both options and stocks are actively traded on exchanges, so there is little liquidity risk for both. Options contracts lose time premium as the position nears expiration; this is not true for stock positions.)

An investor purchases 1 ABC Jan 45 Put @ $3. The investor subsequently exercises his option contract. The holder has the right to: A. buy stock at $42 per share B. buy stock at $45 per share C. sell stock at $42 per share D. sell stock at $45 per share

D. sell stock at $45 per share

If the writer of an equity call contract is exercised, the writer must deliver: A. cash in 1 business day B. stock in 1 business day C. cash in 2 business days D. stock in 2 business days

D. stock in 2 business days

The break-even point for the HOLDER of a call is: A. the premium paid B. unlimited C. strike price minus premium paid D. strike price plus premium paid

D. strike price plus premium paid

A customer sells 1 ABC Feb 40 Call @ $2 when the market price of ABC is $39.50. The customer's maximum potential loss is: A. $200 B. $3,950 C. $4,200 D. unlimited

D. unlimited

The option premium is: I the price of the contract II the strike price of the contract III determined by supply and demand in the marketplace IV determined by the Options Clearing Corporation A. I and III B. I and IV C. II and III D. II and IV

I and III -The price of the contract & determined by supply and demand in the marketplace

A customer who is long 1 ABC Jan 40 Call wishes to create a "bear call spread." The second option position that the customer must take is: A. Long 1 ABC Jan 30 Call B. Short 1 ABC Jan 30 Call C. Short 1 ABC Jan 50 Call D. Short 1 ABC Jan 40 Put

B. Short 1 ABC Jan 30 Call (A spread consists of the purchase and sale of the same type of option (calls in this case) with different strike prices and/or expirations. In a bear call spread (the same as a short call spread), the customer hopes that the market will fall, but does not want to incur unlimited risk if the market were to rise. If a customer is long an ABC Jan 40 Call, he or she will lose the premium paid if the market falls below $40. But if the customer sells a lower strike price call (this will have a higher premium since it is more valuable to the purchaser of the option because it allows the stock to be purchased at a lower price), the customer will collect a larger premium, for a net credit position. If the market drops below 30 (in this case) both the long 40 call and the short 30 call expire "out the money" and the credit received is the profit. Conversely, if the market rises, there is no longer unlimited upside risk on the short call position. If the market rises sharply, the customer will be exercised on the short 30 call, and must deliver the stock for $30 per share. The customer can exercise the long 40 call, buying the stock at $40 for delivery. Thus, the loss potential has been limited to 10 points.)

Which of the following options strategies provides a gain equal to the premium in a bear market? A. Long Call B. Short Call C. Long Put D. Short Put

B. Short Call (The writer of a call (short call) collects a premium in return for agreeing to sell stock at a fixed price, no matter how high the market price of the stock may go. If the market price falls, the call expires "out the money" and the writer keeps the collected premium. This is the maximum potential gain.)

An investor writes 1 ABC Jan 45 Put @ $3. The contract subsequently is exercised. The writer is obligated to: A. buy stock at $42 per share B. buy stock at $45 per share C. sell stock at $42 per share D. sell stock at $45 per share

B. buy stock at $45 per share

The premium on a call or put option is the: A. exercise price of the contract B. cost of the contract C. market price of the underlying instrument D. cost of the underlying instrument

B. cost of the contract

A customer would buy put contracts because the customer: A. is bullish on the underlying security B. is bearish on the underlying security C. is neutral on the underlying security D. wishes to generate ordinary income

B. is bearish on the underlying security

A customer would sell call contracts because the customer: A. is bullish on the underlying security B. is bearish on the underlying security C. wishes to generate earned income D. wishes to defer taxation of gains on the underlying stock

B. is bearish on the underlying security

The sale of index calls against a portfolio of listed securities is a: A. covered writing strategy B. naked writing strategy C. horizontal spread strategy D. bullish strategy

B. naked writing strategy (If the writer of index calls is exercised, he does not deliver the stocks in the index - he delivers cash. Index call writing against a portfolio of securities is therefore considered to be a "naked" writing strategy. As with any "income writing" strategy where the call writer owns the physical instrument or an equivalent, the writer expects the market to remain neutral or is mildly bearish.)

To establish 1 ABC Jan 65 Short Call position, an order ticket must be marked: A. opening purchase B. opening sale C. closing purchase D. closing sale

B. opening sale

To establish a short put position, an order ticket must be marked: A. opening purchase B. opening sale C. closing purchase D. closing sale

B. opening sale

The maximum loss for the writer of a call is: A. the premium received B. unlimited C. strike price minus premium received D. strike price plus premium received

B. unlimited (Also known as the "seller" of the call)

On the same day, a customer buys 100 shares of ABC at $25 and sells short 100 shares of XYZ at $35. The customer then buys 1 ABC Jan 25 Put @ $4 and 1 XYZ Jan 35 Call @ $6. XYZ rises to $42 and the customer exercises the call. ABC falls to $19 and the customer exercises the put. The net gain or loss on all transactions is: A. $200 loss B. $1,000 gain C. $1,000 loss D. breakeven

C. $1,000 loss (When XYZ rises, the customer exercises the long call to buy XYZ at $35. This stock is used to cover the short sale of XYZ stock at $35. There is no gain or loss on the stock but the premium paid of $600 for the call is lost. When ABC falls, the customer exercises the long put to sell ABC at $25. Since the customer bought the stock at $25, there is no gain or loss on the stock. However, the customer does lose the $400 paid in premiums for the put. The total loss is $1,000.)

A customer sells 2 ABC Jan 40 Calls @ $5 when the market price of ABC is at $39. The breakeven point is: A. $29 B. $30 C. $45 D. $50

C. $45

What is the "intrinsic value" of the following contract? 1 ABC Jan 55 Put @ $9 ABC Market Price = $49 A. $2 B. $4 C. $6 D. $8

C. $6

If it is now the month of November, which contract will likely have the highest premium when ABC closes at $38? A. ABC Dec 35 Call B. ABC Dec 35 Put C. ABC Jan 35 Call D. ABC Jan 35 Put

C. ABC Jan 35 Call. (The contract with the highest premium is likely to be the one that is the most "in the money" and the one with the longest time to expiration. With the market price at $38, the 35 call is "in the money" by 3 points. The 35 put is "out the money" by 3 points. Since it is now November, the January call has about 2 months to expiration, while the December call has only about 1 month to expiration. Therefore, the contract that is "in the money" by the greatest amount, and which has the longest time to expiration, is the ABC January 35 call.)

Which of the following statements is TRUE when comparing the purchase of a put and selling a security short? A. The maximum potential loss for both positions is unlimited B. The capital requirement to purchase a put and the capital requirement to sell a security short are the same C. Both positions will have the maximum potential gain if the market falls to "0" D. There is the same amount of risk in owning a put and in selling a security short

C. Both positions will have the maximum potential gain if the market falls to "0"

A profit to the holder resulting from exercise of an option contract is the: A. premium B. time value C. "out the money" amount D. "in the money" amount

D. "in the money" amount

Which of the following influence the premium of a listed option? I Length of time until expiration of the contract II Volatility of underlying security III Market price of underlying security A. I only B. II only C. III only D. I, II, III

D. I, II, III - (The longer the life of the option, the higher the premium; the greater the volatility of the underlying security, the higher the premium; the higher the market price of the stock, the higher the premium on a call contract (since it goes further "in the money"). The lower the market price of the stock, the higher the premium on a put contract (since it goes further "in the money"). Therefore, all 3 choices influence the premium.)

Which of the following statements are TRUE regarding the premium of an option contract? I The lesser the volatility of the underlying security, the higher the premium II The greater the volatility of the underlying security, the higher the premium III The lesser the time to expiration, the higher the premium IV The greater the time to expiration, the higher the premium A. I and III B. I and IV C. II and III D. II and IV

D. II and IV - The greater the volatility of the underlying security, the higher the premium & The greater the time to expiration, the higher the premium.