Options
A customer sells short 100 shares of PDQ at $47 and sells 1 PDQ Sep 50 Put @ $6. The customer will have a loss at which of the following market prices for PDQ? A $55 B $53 C $47 D $41
The best answer is A. A customer with a short stock / short put position loses if the market rises. The customer sold the stock at $47 and collected $6 in premiums, for a total of $53. To break even, the stock must be bought for this amount. If the stock is bought for more than $53, the customer loses. Therefore, a loss is experienced at $55. To summarize, the formula for breakeven for a short stock / short put position is:
A customer purchases an equity option contract at 1:00 PM Eastern Standard Time on Tuesday, October 10th in a regular way trade. If the customer wishes to exercise, the customer may place an exercise notice with the Options Clearing Corporation: A immediately B no earlier than 10:00 AM Eastern Standard Time, the next business day C no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D no earlier than the Friday immediately preceding the third Saturday of the expiration month
The best answer is A. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation does not handle the exercise until the morning of the next business day (which is also the day that the customer must pay for the option contract). This procedure is followed because the Options Clearing Corporation does not receive the report of the purchase of the option until the close of trading on the day that the contract is purchased. The O.C.C. opens the next day with the customer recorded as being "long" that contract, and can now assign an exercise notice to a writer.
Which of the following are TRUE statements regarding index options? I Upon exercise, the writer must pay to the holder the "in the money amount" II Settlement upon exercise occurs next business day III Settlement is based on the index value at the time of exercise IV The maximum risk for an index option writer is the loss of the premium A I and II B II and III C I, II, III D II, III, IV
The best answer is A. If an index option is exercised, the writer must pay the holder the "in the money" amount the next business day. There is no delivery of the stocks that are in the index - these are termed "cash settled options." The index value is computed as of the close the day of exercise. The writer of an index call has unlimited risk; the writer of an index put has increasing risk as the market drops.
An order ticket which is marked "opening sale" would: I increase open interest if the other side to the trade was an opening purchase II decrease open interest if the other side to the trade was an opening purchase III be liquidated with a closing purchase IV be liquidated with an closing sale A I and III B I and IV C II and III D II and IV
The best answer is A. Opening purchases and opening sales increase open interest; closing sales and closing purchases decrease open interest. Opening purchases are closed with closing sales; opening sales are closed with closing purchases. If a trade is a match of an opening purchase with someone else doing a closing sale; or if the trade is a match of an opening sale with someone else doing a closing purchase, then there is no change in open interest.
The excess of premium paid for an option contract over intrinsic value is called the: A time premium B total premium C out the money amount D in the money amount
The best answer is A. The "time" premium (or time value) on an options contract is the amount paid for the option, over and above "intrinsic value." The greater the time to expiration, the greater the time premium will be.
A customer buys 1 ABC Jan 70 Call @ $4 and buys 1 ABC Jan 70 Put @ $1 on the same day when the market price of ABC stock is $72. Assume that the market price falls to $66 and the call premium falls to $.50, while the put premium rises to $5.50. The customer closes the positions. The customer has a: A $100 gain B $100 loss C $500 gain D $500 loss
The best answer is A. The customer established two positions with a debit of $5 x 1 contract = $500 debit. When the market is at $66, the customer closes the call at $.50 and closes the put at $5.50. Thus, the positions are closed at: Short 1 ABC Jan 70 Call@ $ .50Short 1 ABC Jan 70 Put@ $5.50 $6.00credit = $600 credit The customer closed for a credit of $600. Since the initial positions cost $500, the customer has a $100 gain.
A customer sells 1 ABC Jul 55 Call @ $6 and 1 ABC Jul 65 Put @ $6 on the same day. Just prior to expiration, the stock is trading at $63 and the customer closes the positions at intrinsic value. The customer has a net profit of: A $200 B $400 C $800 D $1,200
The best answer is A. The customer has sold a short combination, receiving combined premiums of $1,200. When the stock is at $63, the short 65 put is 2 points "in the money," resulting in a 2 point loss to the writer, while the short 55 call is 8 points "in the money," resulting in an 8 point loss to the writer. $1,200 received in premiums net of $1,000 loss = $200 profit.
A customer sells 1 ABC Mar 40 Call @ $3 when the market price of ABC is at $41. ABC goes to $43 and just prior to expiration, the customer closes his option contract at intrinsic value. The customer has a: A no gain or loss B $200 gain C $300 gain D $300 loss
The best answer is A. The customer's contracts are not exercised. The customer initially sells the call at $3. Since he or she receives the $3, this is a credit. To close the position, the customer must buy back the option (opening sale is closed with a closing purchase). He or she buys back the position at "intrinsic value" - if the strike price of the call is $40 and the market price of the stock of $43, the call has "intrinsic value" of 3 points. If the call is purchased in a closing trade at $3, there is no gain or loss since the position was opened at a premium of $3.
The main advantage of buying a call option as opposed to buying the underlying stock is: A lower capital requirement B both receive dividends from the issuer C both have pre-emptive rights D greater liquidity
The best answer is A. The main advantage of buying a call option as opposed to buying the shares of that issuer is that the premium paid is much lower than the cost of buying the stock. However, call holders do not receive dividends, nor do they have any shareholder rights. Calls lose time premium as they get closer and closer to expiration, whereas stockholders do not experience such a loss. There is ready liquidity in both the options markets and the stock markets, so there is no meaningful advantage of one as compared to the other in this respect.
What is the "time premium" amount of the following contract? 1 ABC Jan 55 Put @ $2 ABC Market Price = $61 A $2 B $4 C $6 D $8
The best answer is A. This contract is "out the money," so there is no intrinsic value currently. The total premium paid of $2 represents the "time premium" for this contract.
What is the "time premium" amount for the following contract? 1 ABC Jan 45 Call @ $4 ABC Market Price = $49 A 0 B 1 C 3 D 4
The best answer is A. Time premium is any premium paid above intrinsic value. In this case, the holder of the call can buy the stock at the strike price of $45 when the market price is $49, for a $4 profit to the holder. This is the "intrinsic value" in the contract. Since the premium is $4, there is no additional time premium that is being paid above intrinsic value. Note that this only happens when contracts are very close to expiration.
An options strategy where the maximum potential loss is equal to the difference between the value of the underlying long securities position and premiums received is a: A naked call writer B covered call writer C naked put writer D covered put writer
The best answer is B. A covered call writer sells a call contract against the underlying stock that is owned by that customer. If the market drops, the call expires unexercised and the customer keeps the premium. However, as the market drops, the customer loses on the long stock position. Thus, the maximum potential loss is the full value of the stock position, net of collected premiums.
A customer buys 1 ABC Jan 35 Call @ $3.50 and 1 ABC Jan 35 Put @ $.50 when the market price of ABC is at $34.75. ABC stock moves to $29 and stays there. Just prior to expiration, the positions are closed at intrinsic value. The gain or loss is: A 0 B $200 gain C $600 loss D $600 gain
The best answer is B. 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 1 ABC Jan 35 Call@ $3.50Buys 1 ABC Jan 35 Put@ .50 $4.00 Debit If the market drops below $35, 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) 6 points. This results in a 6 point profit on the put, if it is "closed" (sold) at intrinsic value. But, since 4 points were paid in premiums, the customer has a net gain of 2 points per share, or $200 per contract.
A customer purchases an equity option contract in a regular way trade at 1:00 PM Eastern Standard Time on Tuesday, October 10th, and files an exercise notice at 3:00 PM on the same day. The option contract will first be assigned by the Options Clearing Corporation: A immediately B no earlier than 10:00 AM Eastern Standard Time, the next business day C no earlier than 10:00 AM Eastern Standard Time, on the 3rd business day following trade date D no earlier than the Friday immediately preceding the third Saturday of the expiration month
The best answer is B. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation does not handle the exercise until the morning of the next business day (which is also the day that the customer must pay for the option contract in a regular way settlement). This procedure is followed because the Options Clearing Corporation does not receive the report of the purchase of the option until the close of trading on the day that the contract is purchased. The O.C.C. opens the next day with the customer recorded as being "long" that contract, and can now assign an exercise notice to a writer.
A customer buys a listed stock option in a regular way trade and exercises that same day. The Options Clearing Corporation will assign the exercise notice to a writer on: A that day B the next business day C the 2nd business day after exercise date D the 5th business day after exercise date
The best answer is B. An exercise notice may be placed by a customer immediately upon the purchase of a call or put contract. However, the Options Clearing Corporation will not assign the exercise notice until the purchase of the option settles - and this occurs the next business day for a regular way options trade. Once the assignment occurs, the stock must be delivered to the holder of the call; or the stock must be delivered to the writer of the put; 2 business days after assignment.
A customer that owns stock and that is bullish on the market would sell covered calls on that stock above the market instead of buying calls on that stock for all of the following reasons EXCEPT to: A increase income from the stock position B maximize upside price appreciation C minimize the capital commitment D reduce loss potential on the stock position
The best answer is B. If a customer sells a call against stock that he or she owns, a premium is collected. This reduces the cost of the stock position (hence reducing the potential loss on the stock position) and gives the call writer premium income. In return for this, the call writer gives up any "upside" gain potential on that stock (above the strike price of the call). Therefore, upside price appreciation is limited.
A customer would receive protection on a long stock position from which TWO of the following? I Buy a call II Sell a call III Buy a put IV Sell a put A I and III B II and III C I and IV D II and IV
The best answer is B. 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 the stock at the exercise price if the market falls - protecting the stock position from downside market risk. However, buying a put is not given as a stand alone choice. If one were to sell a call against a long stock position, then if the stock's market price falls, the call expires out the money. The premium received is a form of limited protection as the market drops. However, if the stock's price falls greatly, then the premium received is not enough to compensate for the loss in the value of the stock. Buying a call would not give downside protection - if the market drops, the call expires out the money and the premium is lost, in addition to any loss on the stock position. Writing a put does not give downside protection - in a falling market, the short put would be exercised, obligating the put writer to buy the stock at the strike price. The writer would lose on this stock position, in addition to losing on the original stock position, in a falling market.
What is the "intrinsic value" of the following contract? 1 ABC Jan 45 Call @ $4 ABC Market Price = $45 A -$4 B $0 C $4 D $9
The best answer is B. Intrinsic value is the amount by which an option contract is "in the money" - it has nothing to do with the premium. It is the difference between the strike price and market price, if exercise is profitable to the holder. In this case, the holder of the call can buy the stock at the strike price of $45 when the market price is $45, for no profit or loss to the holder. There is no "intrinsic value" in the contract.
Which of the following will decrease "open interest"? I Opening Purchase II Opening Sale III Closing Purchase IV Closing Sale A I and II B III and IV C I and IV D II and III
The best answer is B. Open Interest is the number of option contracts (both calls and puts) outstanding. Opening purchases and opening sales increase open interest; closing sales and closing purchases decrease open interest. The greater the open interest, the greater the likely trading volume in the issue.
An order ticket which is marked "opening purchase" would: I increase open interest if the other side to the trade was an opening sale II decrease open interest if the other side to the trade was an opening sale III be liquidated with a closing purchase IV be liquidated with an closing sale A I and III B I and IV C II and III D II and IV
The best answer is B. Opening purchases and opening sales increase open interest; closing sales and closing purchases decrease open interest. Opening purchases are closed with closing sales; opening sales are closed with closing purchases. If a trade is a match of an opening purchase with someone else doing a closing sale; or if the trade is a match of an opening sale with someone else doing a closing purchase, then there is no change in open interest.
A customer buys 1 ABC Feb 50 Call @ $7 when the market price of ABC is $52. If the stock stays at $52 and just prior to expiration, the customer closes out the position with a closing sale at intrinsic value, the gain or loss is: A $200 gain B $500 loss C $700 gain D $900 loss
The best answer is B. The customer established the long call position with an opening buy at $7. He closes the position with a sale at $2 (intrinsic value when the call strike price is $50 and the market price is $52). The net loss is $7 - $2 = $5 per share or $500
Floor brokers on the Chicago Board Options Exchange: I can accept all orders II can only accept orders that are "away" from the market III can maintain bid and ask quotes IV cannot maintain bid and ask quotes A I and III B I and IV C II and III D II and IV
The best answer is B. The floor broker is an individual who executes transactions for retail member firms on the CBOE. The floor broker can trade with another floor broker, a Market Maker or an Order Book Official, earning a fee for each transaction. Floor brokers cannot maintain a bid-ask quote - they cannot be market makers. They can accept all orders, and are obligated to find the best available market. Regarding orders that are "away" from the market, that is, orders that cannot be executed immediately, these orders would be placed on the Order Book Official's book of open orders.
An investor has sold short 500 shares of ABC at $60. The stock has since declined to 38. All of the following can be used to protect the gain EXCEPT: A place a buy stop order at $40 B buy 5 ABC 40 puts C buy 5 ABC 40 calls D sell 5 ABC 40 puts
The best answer is B. The investor has a gain on the short stock position that will evaporate as the market rises. To protect the gain, the stock must be bought in if the market begins to rise. A buy stop order is executed in a rising market, and would be appropriate to close the short position if the market rises. The purchase of a call allows the stock to be bought in at the strike price if the market rises, protecting the gain. If a put is sold and the market rises, the put will expire worthless, and the writer will keep the premium received. This amount of premium received will reduce any loss on the short stock position if the market rises. The purchase of a put will not protect the gain, since it allows the stock to be sold at the strike price. If exercised, the long put will cause the customer to have sold the stock TWICE.
A customer buys 100 shares of XYZ at $51 and buys 1 XYZ Jan 50 Put @ $5. The maximum potential loss is: A $500 B $600 C $4,600 D unlimited
The best answer is B. The long put gives the stock owner the right to sell at $50. Since he bought the stock at $51, exercising results in a 1 point stock loss. In addition, the premiums paid of $5 are lost, for a total loss of 6 points or $600 maximum.
An American Style stock option differs from a European style stock options because it can be: A traded anytime until expiration B exercised anytime until expiration C issued at any time until expiration D redeemed anytime until expiration
The best answer is B. The very first options contracts were single stock options, which started trading on the CBOE in 1973. All single stock options are "American Style" - these are options that can be exercised at any time. In contrast, European style options can only be exercised at expiration and not before. All options contracts can be traded anytime until expiration. Options contracts cannot be redeemed and they can only be issued based on the cycles set by the Options Clearing Corporation.
A customer sells 2 ABC Jan 40 Puts @ $9 when the market price of ABC is $36. The breakeven point is: A $30 B $31 C $48 D $49
The best answer is B. The writer collected $9 in premiums by obligating him- or herself to buy the stock at $40. If exercised, the customer's net outlay is $31 for the stock. To breakeven, the customer must be able to sell the position for $31. To summarize, the formula for breakeven on a short put is:
ABC corporation is trading in the market for $61. The corporation declares a 50% stock dividend. After the ex date, the holder of 1 ABC Jan 60 Call will have: A 1 ABC Jan 30 Call B 1 ABC Jan 40 Call C 1.5 ABC Jan 40 Calls D 1 ABC Jan 60 Call
The best answer is B. This is a stock dividend of 50%. The contract is adjusted by reducing the strike price and increasing the number of shares covered by the contract. The contract holder owns 1 ABC Jan 60 Call. The strike price becomes $60/1.50 = $40 and the number of shares covered by the contract becomes 1.50 x 100 = 150 shares. Note that the aggregate exercise value of the contract is unchanged.
The "time premium" on following contract is? 1 ABC Jan 45 Call @ $5 ABC Market Price = $49 A $0 B $1 C $4 D $5
The best answer is B. Time premium is any premium paid above the intrinsic value of the contract. In this case, the holder of the call can buy the stock at the strike price of $45 when the market price is $49, for a $4 profit to the holder. This is the "intrinsic value" of the contract. Since the total premium is $5, the time premium is $1.
An investor has bought 500 shares of a volatile growth stock and wishes to limit downside loss. Which strategies are appropriate? I Place a buy stop order II Place a sell stop order III Buy 5 put contracts IV Sell 5 put contracts A I and IV B II and III C I and III D II and IV
The best answer is B. To limit loss on a long stock position, the investor wants to sell if the market drops. To sell in a falling market, the appropriate order is a sell stop order. Another strategy that would work is the purchase of a put contract, giving the investor the right to sell at the strike price should the market drop.
DEF Corporation, after many profitable years, declares a one-time special cash dividend of $5.00 per share. After the announcement, the stock is trading at $50 per share. Your customer holds 1 DEF Jan 55 Call. As of the ex date, the customer will have: A 1 DEF Jan 45 Call B 1 DEF Jan 50 Call C 1 DEF Jan 55 Call D 1 DEF Jan 60 Call
The best answer is B. While the OCC does not adjust the strike prices of listed options contracts for regular quarterly cash dividends, since they are a "known quantity" that the market prices into options premiums, "special cash dividends" are a one-time event that the market does not know about. Therefore, the OCC does adjust listed options for special cash dividends that amount to at least $12.50 per contract. Since this special cash dividend amounts to $5 per share x 100 shares = $500 value per contract, it will be adjusted. The new strike price will be 55 - $5 cash dividend = 50. The number of shares covered by the contract does not change.
If the market price and the strike price are the same at expiration, which of the following open options positions will result in a loss? I Long Call II Short Call III Long Straddle IV Short Straddle A I and II B III and IV C I and III D II and IV
The best answer is C. "At the money" contracts will expire unexercised. Any holders lose the premium, while writers gain the premium.
A client believes that XYZZ stock has topped out in price and is ready for a steep drop. What recommendation would give the customer the smallest profit if this occurs? A Buy an XYZZ put option B Sell short XYZZ stock C Sell an XYZZ call option D Buy 1 XYZZ warrant
The best answer is C. A long put option gives ever-increasing profit as the market drops, as does selling the stock short. The maximum profit for either strategy occurs if the stock drops to "0." A short call option will expire when the market drops, giving the writer a gain only equal to the premium collected. Warrants allow the owner to buy the common stock at a fixed price, typically good for up to 5 years from issuance. They are attached to the sale of new bond and preferred stock offerings, to help make them more marketable. If the market falls, the warrant will expire worthless, and the customer will have a loss - not a gain!
Which of the following cover a short ABC put? I Long ABC stock position II Short ABC stock position III Cash equal to the aggregate exercise price A I only B II only C II and III D I, II, III
The best answer is C. A long stock position is not considered "cover" for a short put since as the market goes down, the short put is exercised and there is increasing loss on the stock position. The O.C.C. accepts as "cover" a long put with the same strike price or higher (thus creating a long put spread), a bank guarantee letter (where the bank assumes responsibility for loss), or an escrow receipt for cash sufficient to pay for the stock should the put be exercised. A short stock position also covers a short put, since the credit from the sale of the stock is available to "pay" for the purchase of the stock should the short put be exercised.
Under O.C.C. rules, all of the following would "cover" a short put EXCEPT a(n): A long put on the same stock with the same strike price or higher with the same expiration or later B bank guarantee letter C long stock position in the underlying security D escrow receipt for cash equal to the exercise price held in a bank vault
The best answer is C. A long stock position will not "cover" a short put. If the market goes down, the short put is exercised, obligating the customer to come up with the cash to buy the stock. Having a long stock position is of no help here, since the customer has increasing loss on the stock position in a falling market, in addition to the loss experienced on the short put. The O.C.C. accepts as "cover" a long put with the same strike price or higher (thus creating a long put spread), a bank guarantee letter (where the bank assumes responsibility for loss), or an escrow receipt for cash sufficient to pay for the stock should the put be exercised. A short stock position also covers a short put, since the credit from the sale of the stock is available to "pay" for the purchase of the stock should the short put be exercised.
Which of the following contracts has the greatest intrinsic value? A ABC Jan 50 Call when the market price of ABC stock is $55 B ABC Jan 50 Call when the market price of ABC stock is $50 C ABC Jan 50 Put when the market price of ABC stock is $40 D ABC Jan 50 Put when the market price of ABC stock is $60
The best answer is C. Calls go "in the money" when the market price rises above the strike price. Puts go "in the money" when the market price falls below the strike price. Of the contracts listed, Choice A and Choice C are "in the money." A 50 Call when the market is at $55 is 5 points "in the money." And a 50 Put when the market price is $40 is "in the money" by 10 points.
An investor holds 1 ABC Jan 80 Call. ABC splits 2 for 1. On the ex date, the holder will have: A 1 ABC Jan 40 Call B 1 ABC Jan 80 Call C 2 ABC Jan 40 Calls D 2 ABC Jan 80 Calls
The best answer is C. For whole share splits, the number of contracts is increased and the strike price is reduced proportionately. 1 ABC Jan 80 Call becomes (after the 2 for 1 split) 2 ABC Jan 40 Calls (the new strike price is 80/2), with each contract covering 100 shares. Note that the aggregate exercise value of the contracts remains unchanged.
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
The best answer is C. If the holder of an equity call exercises, he is buying the stock at the strike price. Settlement is 2 business days after exercise date - this is a regular way stock trade.
The Standard and Poor's 100 Index has closed at 675.12, up .40 from the prior day's close. The holder of 10 "deep in the money" OEX Call contracts would have an approximate gain of: A $4 B $40 C $400 D $4,000
The best answer is C. Index option contracts have a multiplier of 100. A change of .40 equals 100 x .40 = $40.00 per contract. Since this person holds 10 contracts, the change in value is 10 x $40 = $400.
A customer buys 5 ABC Jan 60 Calls @ $4 and buys 5 ABC Jan 60 Puts @ $1 on the same day when the market price of ABC stock is $62. Assume that the market price falls to $56 and the call premium falls to $.50, while the put premium rises to $5.50. The customer closes the positions. The customer has a: A $100 gain B $100 loss C $500 gain D $500 loss
The best answer is C. The customer established the positions with a debit of $5 x 5 contracts = $2,500 debit. When the market is at $56, the customer closes the calls at $.50 and closes the puts at $5.50. Thus, the positions are closed at: Short 5 ABC Jan 60 Calls@ $ .50Short 5 ABC Jan 60 Puts@ $5.50 $6.00credit x 5 contracts = $3,000 credit The customer closed for a credit of $3,000. Since the initial positions cost $2,500, the customer has a $500 gain.
A customer takes the following positions when the Standard and Poor's 100 average closes at 544.15. Buy 1 OEX Dec 550 Call @ $5 Sell 1 OEX Dec 535 Call @ $16 The customer will profit if: I The spread narrows below 11 II The spread widens above 11 III The S&P 100 Index remains unchanged IV The S&P 100 Index falls A I and III B II and IV C I, III, IV D II, III, IV
The best answer is C. The customer has created a bear call spread, receiving a net credit of 11 points. The spread will be profitable if it can be closed out with a debit smaller than 11; so the spread must narrow. If the spread widens above 11, then the spread will be closed out at a debit larger than 11 and there will be a loss. If the S&P 100 index falls, both calls expire out the money and the 11 point credit is kept. The S&P 100 index remains unchanged at 544.15, the long 550 call expires out the money, while the short 535 call is in the money by 9.15 points and the writer loses this amount. Since 11 points were received in premiums, he or she still has a net gain.
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.
A customer sells 2 ABC Jan 50 Calls @ $3 when the market price of ABC is at $52. The maximum potential gain for the position is: A $200 B $300 C $600 D unlimited
The best answer is C. The maximum potential gain for the writer of a naked call option is the premium received. This occurs if the market drops and the call expires "out the money." In this case, there are 2 contracts, so the maximum gain is the $300 collected premium x 2 contracts = $600.
Which of the following options strategies provides the greatest profit potential in a bear market? A Long Call B Short Call C Long Put D Short Put
The best answer is C. The purchaser of a put (long put) has the right to sell stock at a fixed price, no matter how low the market price of the stock may go. This strategy has increasing gain potential as the market falls, with the maximum gain occurring if the market falls to "0."
An investor has 1 ABC Jan 50 Call contract. ABC declares a 25% stock dividend. Which statement is TRUE regarding the option contract after adjustment for the dividend? A The contract becomes 1 ABC Jan 60 Call covering 125 shares B The contract becomes 1 ABC Jan 40 Call covering 100 shares C The contract becomes 1 ABC Jan 40 Call covering 125 shares D The contract stays as 1 ABC Jan 50 Call covering 100 shares
The best answer is C. This is a stock dividend of 25%. The contract is adjusted by reducing the strike price and increasing the number of shares covered by the contract. The contract holder owns 1 ABC Jan 50 Call. The strike price becomes $50/1.25 = $40 and the number of shares covered by the contract becomes 1.25 x 100 = 125 shares. Note that the aggregate exercise value of the contract is unchanged.
The New York Stock Exchange stops the trading of a company's stock, pending release of an important news announcement. The trading of the option will be halted by the: A Options Clearing Corporation B Specialist (DMM) on the NYSE floor C Exchange where the option trades D Issuer of the securities
The best answer is C. When an exchange stops trading in a stock, the options exchange stops trading in the option (since there is no longer a way to price these "derivative" securities, whose price is based on the price movements of the underlying stock)
A mutual fund manager of a country 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
The best answer is D. A "country" fund is composed of the stocks of companies located in a single country, such as the Japan Fund; or the Mexico Fund. The volatility of such funds differs from the volatility of the market as a whole. The best way to hedge is with index puts, such as the Japan index option; or the Mexico index option. These are narrow based contracts.
A customer is long an ABC Jan 60 Put. 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 buy purchasing that option contract; or the customer can open by purchasing an option contract and will close by selling that option contract.
When the O.C.C. receives an exercise notice from a brokerage firm, it selects a short contract to be exercised on a: A method of reasonable fairness B LIFO basis C FIFO basis D random order basis
The best answer is D. If an option contract is exercised by a holder, a writer is selected by the Options Clearing Corporation to perform on the contract on a random order basis.
If the market price is much higher than the strike price at the time of expiration, which of the following open options positions is likely to result in a gain? I Long Put II Short Put III Long Straddle IV Short Straddle A I and II B III and IV C I and III D II and III
The best answer is D. If the market price is higher than the strike price, the long put contract would expire "out the money," so the buyer will lose the premium paid for the position. Conversely, if a customer sells a put, and the market goes up, the contract will expire "out the money" and the customer earns the premium. A long straddle contains a long call and a long put. The call would be exercised at a profit if the market goes up. A short straddle contains a short call and a short put. If the market rises, the naked short call will be exercised, obligating the writer to deliver shares at a fixed (lower) price. The loss potential is unlimited as the market rises.
The December stock option contracts of a company assigned to Cycle 2 have just expired. Which contracts will commence trading on the CBOE? A January B February C May D August
The best answer is D. The options cycles are: Cycle 1JanAprJulOctCycle 2FebMayAugNovCycle 3MarJunSepDec Cycle 2 contracts are issued for the months of Feb - May - Aug - Nov. One can always get a contract for this month, next month, and the next 2 months in the Cycle. In December, prior to expiration, the contracts that will trade are December (this month), January (next month), February and May (the next 2 months in the cycle). After December contracts expire, the contracts that will trade are January (this month), February (next month), May and August (the next 2 months in the cycle).
A customer sells 1 ABC Jan 50 Call and sells 1 ABC Apr 60 Put. The customer has created a: A bull spread B short straddle C married put D short combination
The best answer is D. The sale of a call and a put on the same stock with the different strike prices and/or different expirations is a short combination. A short straddle is the sale of a call and a put on the same stock with the same strike prices and expiration dates.
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
The best answer is D. 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.
A customer is long 100 shares of ABC stock purchased at $30. The stock is now trading at $42. The customer believes that the stock has the potential to move up to $55 a share, but no further. The customer would like to generate extra income and also enjoy the limited upside gain potential in the stock. To do this, the customer should: A buy 1 ABC Jan 40 Call B sell 1 ABC Jan 40 Call C buy 1 ABC Jan 55 Call D sell 1 ABC Jan 55 Call
The best answer is D. This customer bought the stock at $30, and it is now worth $42. The customer believes that the stock will rise to $55, so he does not want to sell a 40 call on that stock (since it will be called away if the price stays above $40). If the customer sells a 55 call, the customer will collect a smaller premium, but he or she will collect something - so this meets the requirement to generate income. As long as the stock price does not rise above $55, the customer will enjoy the price rise in the stock and the stock will not be called away.
An investor has a portfolio of diversified blue chip stocks with a current market value of $1,000,000. The portfolio has a computed beta factor of 2. The customer wants to protect the portfolio from a declining market with the use of OEX contracts. The OEX closed this day at 500. To hedge with "at the money" contracts, the customer should: A Buy 5 OEX Puts B Buy 10 OEX Puts C Buy 20 OEX Puts D Buy 40 OEX Puts
The best answer is D. To hedge the portfolio, puts should be purchased. If the market value drops, any loss on the portfolio will be offset by a gain on the long puts. If the portfolio were as volatile as the market, 20 put contracts would be needed to hedge. (500 OEX strike price x multiplier of 100 = $50,000 value covered per contract. $1,000,000 portfolio divided by $50,000 coverage per contract = 20 contracts) However, this portfolio moves 2 times as fast as the market, so 2 times the number of contracts is needed to hedge. 2 x 20 contracts = 40 contracts.
