Q Bank Unit 4

Your client writes 2 ABC November 220 calls at 5, and buys 200 shares of ABC common stock at $220 in his margin account. What is the breakeven point for each covered call position? A) 215. B) 210. C) 225. D) 230.

Answer: A The breakeven point for covered call writing is the cost of stock purchased less the premium (220 − 5).

A client writes 1 Apr 30 call and buys 1 Apr 40 call. This is a: bull spread. bear spread. debit spread. credit spread. A) II and IV. B) I and III. C) I and IV. D) II and III.

Answer: A This is a call credit spread, and bears sell calls. The 30 call is worth more because it has a lower strike price. Long the lower is bullish; short the lower is bearish.

Mr. Jones calls his registered representative and places an order to write an XYZ Oct 90 call and at the same time to write an XYZ Oct 80 put. The orders are executed at a premium of 5 for the call and 9 for the put. Which of the following best describes the customer's investment strategy? A) Neutral strategy. B) Bullish strategy. C) Bearish strategy. D) Mixed strategy.

Answer: A A customer who writes both a call and a put on the same underlying security wishes for little or no market movement. This is referred to as a neutral strategy. Technically, the customer has created a short combination (an investment position very similar to a short straddle, with the same investment characteristics), and, in this case, a little less risk than a pure straddle because of the spread in the strike prices.

An investor buys an ABC May 45 put at 4.25 when the stock is trading at $43. The put is in-the-money when the stock is: A) below 45. B) below 38.75. C) below 40.75. D) above 47.25.

Answer: A A put is in-the-money when the underlying stock trades below the exercise price of the put. The put is in the money by 2 points.

An investor would sell a put: A) because he is bullish. B) as a substitute for a short sale. C) because he is bearish. D) as an inflation hedge.

Answer: A A put seller (writer) will benefit as long as the market price of the underlying security does not drop substantially. His position is bullish.

If a customer sells short 100 ABC at 40 and sells 1 ABC June 40 put at 4, what is the maximum loss? A) Unlimited. B) 0. C) 400. D) 3600.

Answer: A A short stock position subjects an investor to unlimited risk. Writing a put against a short stock position only protects the investor to the extent of the premium received.

A customer who is long 1 XYZ Sep 50 call could create a spread by combining it with which of the following positions? A) Short 1 XYZ Sep 60 call. B) Long 1 XYZ Sep 50 put. C) Short 1 XYZ Sep 50 put. D) Long 1 XYZ Sep 60 call.

Answer: A A spread involves two simultaneous positions in related options of the same type-one long and the other short of the same underlying security.

If a customer buys 5 ABC Sep 50 calls at 5 and 5 ABC Sep 50 puts at 3, this position is called a: A) straddle. B) spread. C) ratio write. D) hedge.

Answer: A A straddle is an option strategy in which the investor holds a position in both a call and a put with the same strike price, expiration, and underlying security.

What are the breakeven points on the following position? Write 2 DWQ Apr 30 calls at 2.25. Write 2 DWQ Apr 30 puts at 2.10. 25.65. 27.85. 32.25. 34.35. A) I and IV. B) I and III. C) II and III. D) II and IV.

Answer: A A straddle, whether long or short, has two breakeven points: the strike price plus, and minus, the sum of the premiums paid or received. In this case, the sum of the premiums received for the two short options is 4.35 and the strike price is 30. If the stock price is greater than 34.35 or less than 25.65, the investor will lose money. With short straddles, the customer profits if the stock price stays inside the breakeven points. Maximum gain is the premium received, and maximum loss is unlimited because of the uncovered calls.

Which of the following positions exposes a customer to unlimited risk? A) All of these. B) Short 200 shares of XYZ. C) Short 2 XYZ uncovered calls. D) Short 200 shares of XYZ and short 2 XYZ puts.

Answer: A All of the positions expose the client to unlimited risk because a loss will occur if the stock price rises.

A customer would buy index calls if he is: A) bullish on the broad market. B) bearish on a particular blue-chip stock. C) bullish on a particular OTC stock. D) bearish on the Fortune 500 stocks

Answer: A An index option is based on the value of the broad market, not the value of an individual security. A person who believes the overall market is rising could take a bullish position and buy calls on the index's value.

If an investor interested primarily in speculation does not expect the price of DWQ stock to change, he or she will: A) write an uncovered straddle. B) write a straddle and buy stock. C) write a straddle and short the stock. D) buy a straddle.

Answer: A An investor who expects prices to remain stable writes an uncovered straddle (short straddle). In selling the put and call at the same terms, the writer collects double premiums. Both expire if the price remains stable, but if the price moves, one side loses money. Short straddles carry unlimited loss potential because of the uncovered call.

If XYZ is currently trading at 32.50, which of the following is 2.50 points in the money? A) Long 1 XYZ 30 call. B) Long 1 XYZ 25 call. C) Long 1 XYZ 25 put. D) Long 1 XYZ 30 put.

Answer: A An option is in-the-money when it has intrinsic value. A call option is in-the-money when the underlying security's price is higher than the option's exercise price.

Which of the following investors will purchase stock if an option is exercised? Owner of a call Owner of a put. Writer of a call. Writer of a put. A) I and IV. B) I and II. C) II and III. D) III and IV.

Answer: A An owner of a call and writer of a put will purchase stock if an option is exercised. Call buyers have the right to buy, and call sellers are obligated to sell; put buyers have the right to sell, and put sellers are obligated to buy.

A registered representative would recommend a customer establish a short straddle on T-bonds when interest rates are expected to: A) remain unchanged. B) rise. C) decline. D) be volatile.

Answer: A Any straddle writer is always looking for a stable market. Volatility is the biggest enemy of the writer. Since this question is referring to debt options, their price movements are based upon changes in interest rates. No fluctuations in interest rates means no price changes.

If a customer buys 5 ABC Jan 40 puts and writes 5 ABC Jan 45 puts, which of the following statements are TRUE? The customer profits if the spread widens. The customer profits if the spread narrows. The customer is a bull. The customer is a bear. A) II and III. B) I and III. C) I and IV. D) II and IV.

Answer: A Because a put is a right to sell, the premium on the 45 puts is higher than that of the 40 puts. The customer is writing the put with the higher premium, so this is a credit spread and the bullish investor will profit at expiration if the difference between the two premiums narrows as the contracts lose value.

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

Answer: A 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.

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) There is no other possible hedge on a long stock position. C) You will gain the option premium, with no chance of loss. D) Your stock covers the option, so you cannot lose.

Answer: A Because the registered representative is recommending covered call writing, he should also explain the risks involved.

An investor, long 100 shares of XYZ at 23.50, writes 1 XYZ May 25 call at 2. At expiration, if XYZ is trading at $20, the investor has a: A) loss of $150. B) gain of $150. C) gain of $50. D) loss of $50.

Answer: A Breakeven is 21.50 (23.50 − 2). If the stock is trading at 20, the customer has an unrealized loss of $150.

A customer buys 200 XYZ at 41 and simultaneously writes 2 XYZ Jan 45 calls at 2. The breakeven point is: A) 39. B) 43. C) 45. D) 47.

Answer: A Breakeven is at 39 because the breakeven point for covered call writing is cost of stock purchased (41) less premium (2). If the stock is sold at 39, the 2-point loss on the stock is exactly offset by the 2-point premium received on the call. Below 39, the customer begins to lose money. Writing calls against a long stock position provides some downside protection to the extent of the premiums received.

Which of the following investors are bearish? Buyer of a call. Writer of a call. Buyer of a put. Writer of a put. A) II and III. B) I and II. C) I and IV. D) III and IV.

Answer: A Buyers of puts and writers of calls are bearish investors. Buyers of calls and writers of puts are bullish investors.

An investor has researched XYZ Corporation and is convinced the company's stock will soon decline in value. If the investor wishes to act on that conviction, which investment strategy will allow the investor to take advantage of the anticipated decline in share value with the smallest cash investment? A) Purchase a put option B) Purchase a call option C) Purchase a call spread D) Sell the company's stock short

Answer: A Buying a put is a basic option strategy utilized when one is bearish on a stock. If the stock declines as anticipated, the investor could exercise the put which allows the stock to be sold at the strike price and then repurchase it at its lower current market price for a profit. The premium paid to buy the put costs less than the margin required if one were to sell the stock short. Purchasing a call or a call spread are bullish options strategies.

If a customer believes the Swiss franc will depreciate against the U.S. dollar, which of the following option strategies may best take advantage of the expected depreciation? A) Uncovered call writing. B) Credit put spread. C) Debit call spread. D) Uncovered put writing.

Answer: A Call writing is bearish, while credit put spreads, debit call spreads, and uncovered put writing are bullish.

If a customer closes his options position, he has: A) placed either a buy order or a sell order. B) placed a buy order. C) placed a sell order. D) exercised the option.

Answer: A Closing an options position means taking a position that represents the opposite side of the opening position. To close a long position, the investor sells an option. To close a short position, the investor buys an option. Because the question does not state whether the investor's opening transaction was long or short, his closing transaction is to either a buy or a sell transaction.

An investor buys 2 LMN 40 calls and pays a premium of 4 each, and also buys two LMN 40 puts and pays a premium of 2.50 each. At the time of purchase, LMN is trading at $40.75. On the expiration date, LMN is trading at $32.50. If the investor closes his position for its intrinsic value. Excluding commissions, the investor realizes a: A) $200 profit. B) $200 loss. C) $100 loss. D) $100 profit.

Answer: A Closing out a position is the opposite of the opening transaction. In this situation, the investor opened by buying 2 calls for a total of $800, and closed them out by selling for their intrinsic value (calls have intrinsic value when the market value is above the strike price; in this situation there is no intrinsic value). The investor also bought 2 puts for a total of $500 and closed them out by selling for their intrinsic value of $1,500 (puts have intrinsic value when the market value is below the strike price; in this situation the intrinsic value is $7.50 per contract) or 40 − 32.50 = 7.5 × 2 = 15 × 100 shares = $1,500). The resulting profit on the position is $200 ($1,500 − $1,300), the total of the premiums paid for all of the options.

Which of the following covers a short call? Long stock. Long a security convertible into the stock. Escrow receipt. Long a call, same strike price or less, same expiration or later. A) I, II, III and IV. B) I only. C) II and III. D) II and IV.

Answer: A 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. If exercised, he can deliver stock without having to purchase it in the open market. A long call only covers a short call if its strike price is equal to, or less than, the strike price of the short call, and the long call's expiration is the same or later. An escrow receipt is a written statement from a bank or other depositor stating that the institution holding the stock will deliver it to the broker/dealer if the customer is exercised. It is also important to note that cash never covers a short call.

Your client's position is: Long 1 CYR 120 call at 4 Long 1 CYR 120 put at 3 Long 100 CYR purchased at 120 If the current market price of CYR is 120, what is the client's maximum possible loss? A) 700. B) 100. C) 487.5. D) 300.

Answer: A If the CYR stock drops to $0, the customer loses $12,000 on the long stock position, but retains the right to put the stock to someone at $12,000, to prevent loss beyond the premium of $300. The call would expire out of the money, for a total loss of $700.

A foreign company that exports its products to the United States wishes to protect itself during a time in which the U.S. dollar is expected to be devalued. The company should: buy U.S. dollars. sell U.S. dollars. buy foreign currency. sell the foreign currency. A) II and III. B) I and III. C) II and IV. D) III and IV.

Answer: A If the company expects the U.S. dollar to become devalued, that means that the foreign currency will become worth more. It would make sense at this time, therefore, for the company to get rid of its U.S. dollars, which are expected to decline in value, and acquire the foreign currency, which will appreciate relative to the U.S. dollar.

A customer long stock who wishes to reduce risk and generate income should: A) sell a call. B) buy a call. C) buy a put. D) sell a put.

Answer: A If the customer sells a call, the risk of owning the stock is reduced by the call's premium; income (the premium) is generated by selling the option.

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 put at 35. B) write a call at 35. C) buy a put and exercise the option. D) buy a 40 call and exercise the option.

Answer: A 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).

An investor establishes the following positions: Long 1 XYZ Apr 40 call for 6 Long 1 XYZ Apr 50 put for 8 If both options are sold for intrinsic value when XYZ trades at 44, the investor realizes a loss of: A) 400. B) 100. C) 200. D) 1000.

Answer: A If the opening purchase of the XYZ Apr 40 call was made at 6, and the closing sale of that call was made at 4, the difference of 2 represents a $200 loss. If the opening purchase of the XYZ Apr 50 put was made at 8, and the closing sale of that put was made at 6, the difference of 2 represents a $200 loss. The total loss for the account is $400.

A speculative investor believes the market in Japanese yen will remain stable for several months. Which of the following positions might allow the investor to take advantage of a lack of movement in the exchange rate between yen and U.S. dollar? A) Short straddle. B) Long straddle. C) Call debit spread. D) Put debit spread.

Answer: A If the spot price does not move, at least one option, perhaps both, will expire unexercised. The other positions will not yield profit without price movement. Note that a short straddle carries unlimited loss potential.

If a customer, long 100 shares of ABC at 47.50, buys 1 ABC Feb 45 put for 2 as a hedge, which of the following statements are TRUE? Breakeven point is 49.50. Breakeven point is 45.50. Maximum loss potential is $450. Maximum loss potential is $4,550. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: A If the stock falls, the customer may exercise the put and sell the stock at 45. Thus, maximum loss on the stock is $2.50. Maximum potential loss is $4.50 per share, or $450, because the customer paid $2 for this protection. The breakeven point is cost of stock purchased plus premium. The stock must rise by an amount equal to the premium paid before the customer can make money. At 49.50, the customer breaks even.

Using yield-based options, which of the following hedging strategies offers a bond portfolio manager the greatest protection against rising long-term interest rates? A) Buy 30-year T-bond yield-based calls. B) Sell 30-year T-bond yield-based calls. C) Buy 30-year T-bond yield-based puts. D) Sell 30-year T-bond yield-based puts.

Answer: A In this example, the options would increase in value as the actual yield on the 30-year Treasury bonds rose above the yield value represented by the strike price of the option.

All of the following option contracts are in-the-money when XYZ is 54 EXCEPT: A) long XYZ 60 put. B) long XYZ 50 call. C) short XYZ 45 call. D) short XYZ 50 put.

Answer: D Call options are in-the-money whenever the market price is greater than the strike price. Put options are in-the-money whenever the market price is lower than the strike price.

On Friday, September 15, an investor goes long 1 OEX Dec 575 call at 7 when the index is at 581.96. At expiration, the investor closes out the long position at intrinsic value when the index is at 580. What amount of money will be deposited in the investor's account on the following Monday, and what will the profit or loss be to the investor? A) $500/$200 loss. B) $696/$196 gain. C) $500/$200 gain. D) $500/$196 loss.

Answer: A Index options settle in cash on the next business day. Each point in an index option is valued at $100. On settlement, the investor will receive the difference between 580 and 575 (5 × 100) or $500. With a cost of 7 ($700), this will create a $200 loss.

In a rising market, all of the following strategies are appropriate EXCEPT: A) short stock/short put. B) short puts. C) long calls. D) debit call spreads.

Answer: A Investors who short stock have sold borrowed shares, and profit when the market price declines.

A customer who buys 1 CDE Oct 60 call at 4 and sells 1 CDE Dec 60 call at 6 has created a: A) calendar spread. B) long straddle. C) combination. D) price spread.

Answer: A Long a call and short a call is known as a call spread. If the strike prices are the same and the expiration months are different (Oct and Dec), it is a calendar spread. Calendar spreads are sometimes called time spreads or horizontal spreads.

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

Answer: A 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.

If a customer buys 1 ABC Jan 50 call at 2 and 1 ABC Jan 50 put at 4 when ABC is at 49, the maximum potential gain is: A) unlimited. B) 200. C) 400. D) 600.

Answer: A Maximum gain in a long straddle is unlimited if the market moves up. If the market moves to zero, the gain is $4,400 (50 − 6 = 44).

A UK company exports sweaters to the U.S. and will be paid in U.S. dollars on delivery. To hedge foreign-exchange risk using listed currency options, the UK company should: A) buy British pound calls. B) sell British pound calls. C) buy British pound puts. D) sell British pound puts.

Answer: A Normally, exporters buy puts on foreign currency in order to hedge. There are no listed currency options available on the U.S. dollar, so the British company should buy calls on its own currency.

If an investor maintaining a short equity option is assigned an exercise notice, which of the following statements is TRUE? A) He must accept the exercise notice. B) He may refuse exercise under certain circumstances. C) He may offset his obligation with a closing transaction until the end of trading on the same day. D) He may offset his obligation with a closing transaction within 3 days.

Answer: A Once exercised, a contract may not be traded to another individual. The exercised party must either deliver (call) or buy (put) the stock in 3 business days.

If an investor purchases 2 Dec 81.50 Swiss franc calls at 2.5, (each contract is 10,000 francs), how much does the investor pay for the position? A) 500. B) 250. C) 2500. D) 81500.

Answer: A One call offered at 2.5 is equal to $250 multiplied by 2 contracts, for a total premium of $500.

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

Answer: A 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.

If ABC closed at 24 and the ABC Mar 20 puts closed at .75, the puts are: A) out-of-the-money. B) in-the-money. C) at the money. D) at parity.

Answer: A Put options are out-of-the-money when the market price is above the strike price.

If a customer writes 1 ABC 60 put at 5 when ABC is trading at 58, which of the following statements are TRUE? The time value of the option is 2 points. The time value of the option is 3 points. Breakeven is 65. Breakeven is 55. A) II and IV. B) I and III. C) I and IV. D) II and III.

Answer: A Puts (long or short) are in-the-money if the market price is below the strike price. In this case, the put is in-the-money by 2 points. The total premium is 5 points, and the time value is 3 points. Option premiums consist of 2 components: intrinsic value and time value. Once the in-the-money amount is determined, it is easy to back into time value. Breakeven for puts (long or short) is the strike price minus premium.

Which of the following listed option orders can be combined to form a spread order? Buy 1 XYZ Jul 30 put. Sell 1 XYZ Jul 35 call. Sell 1 XYZ Jul 35 put. Buy 1 ABC Jul 30 call. A) I and III. B) II and III. C) II and IV. D) III and IV.

Answer: A Spreads are deemed to be of the same class; class is defined as the same underlying security and the same type of option. Choices II and III would be a short straddle. The ABC call cannot be combined with anything, since you'd be combining ABC stock with XYZ stock.

Which of the following would be used to protect against systematic risk? A) Index options. B) Currency options. C) Stock options. D) Interest rate option.

Answer: A Systematic risk is the market risk applied to the value of an entire portfolio instead of just one stock. Therefore, an investor would use index options to protect against systematic risk.

Which of the following entities guarantees a listed yield-based option? A) OCC. B) FRB. C) U.S. government. D) Broker/dealer.

Answer: A The Options Clearing Corporation (OCC) guarantees the performance of listed option contracts

A U.S. company that sells stereo equipment places an order for Japanese stereo components for its inventory. Payment must be made in Japanese yen in 3 months. The U.S. company thinks that the U.S. dollar may weaken against the yen. Which of the following foreign currency option transactions would best protect the U.S. company from a weakening of the U.S. dollar against the yen? A) Buy calls on Japanese yen. B) Buy puts on Japanese yen. C) Sell calls on Japanese yen. D) Sell puts on Japanese yen.

Answer: A The U.S. company is concerned that the value of the Japanese yen will rise. Therefore, the company should buy calls on the yen to lock in the lowest possible price to buy yen for payment of the contract. Importers buy calls to hedge.

Which of the following would best describe, "Bought 1 Jan 55 call at 3 and sold 1 Jan 60 call at 1"? A) A bull vertical spread. B) A bull horizontal spread. C) A bear vertical spread. D) A bear time spread.

Answer: A The client paid 2 points out-of-pocket for a call spread. Break even here is 57. Your client wants the stock to go up; hence, a bull spread. Because the exercise prices are different, it is also a vertical spread.

A customer buys 200 XYZ at 39 and writes 2 XYZ Feb 40 calls at 3. When the stock rises to 44 the customer is exercised for a gain of: A) 800. B) 200. C) 400. D) 1600.

Answer: A The customer bought 200 shares at 39 and was forced to sell them at 40 for a $200 gain. In addition, the customer received $600 in premium income so the overall gain is $800. Alternatively, the breakeven point for covered call writing is cost of shares purchased less premium received (39 − 3 = 36). As the customer is bullish, gain occurs above 36. However, for this customer, the stock can go no higher than 40 because she will be exercised (40 − 36 = 4 points × 200 shares = $800).

A customer writes 1 XYZ Sept 45 put at 6 and 1 XYZ Sept 35 call at 6 when XYZ is at 40. Prior to expiration, if XYZ is at 43 and the customer closes his positions at intrinsic value, the customer has a: A) $200 gain. B) $200 loss. C) $600 gain. D) $600 loss.

Answer: A The customer collects $1,200 in premiums for writing the options (6 + 6), but later pays $200 (45 − 43) to close out the put, and $800 to close out the call (43 − 35). In this case, $1,200 received minus $1,000 paid leaves a gain of $200.

A customer purchases 2 QRS Jul 30 calls at 2 and 2 QRS Jul 30 puts at 2.50. She will break even when the price of the underlying stock is: 25.50. 27.50. 32. 34.50. A) I and IV. B) I and II. C) II and III. D) III and IV.

Answer: A The customer has bought calls and puts with the same strike price and expiration date, so the position is a long straddle. Straddles have two breakeven points: the strike price plus, and minus, the sum of the two premiums. The customer profits in a long straddle when the stock price is outside the breakeven points (i.e., higher than 34.50 or lower than 25.50).

A customer is short 100 XYZ shares at 26 and long 1 XYZ 30 call at 1. What is the maximum potential loss on the positions? A) 500. B) 400. C) 2500. D) Unlimited.

Answer: A The customer has protected his short stock position from loss by purchasing a call. If the market rises, the call is exercised, allowing the customer to buy his stock at the option strike price of 30 to cover the short position. The most the customer can lose is $400 on the stock position (the difference between the option strike price and the stock price) plus the premium paid for the option ($400 + $100 = $500).

If a customer opens a spread on Canadian dollars (10,000 units) by purchasing 1 Dec 74 call for 2.30 and selling 1 Dec 77 call for 1.50, what is the total cost of this debit spread? A) 80. B) 700. C) 800. D) 970.

Answer: A The customer pays a premium of 2.30 ($230) and receives a premium of 1.50 ($150) for a net debit of .80, or $80.

Covered put writing is a strategy where an investor: A) sells a put on a stock he has sold short. B) sells a put on a stock that he owns. C) sells a put and sells a call on the same stock. D) sells a put and buys a call on the same stock.

Answer: A The customer sells the put to generate income. The short stock position provides the necessary cash should his short put be exercised, forcing him to buy the stock.

Your customer tells you that she sees the exchange rate for the British pound in the spot market is listed at 148.47. What do you tell her when she asks you what this means? A) One pound equals $1.4847. B) $1 equals 1.4847 pounds. C) $1 equals 14.847 pounds. D) One pound equals 14.847 U.S. cents.

Answer: A The exchange rate refers to U.S. cents per British pound; 148.47 equals $1.4847.

If an American exporter will be paid 25 million Japanese yen when her goods arrive in 45 days, her best hedge is to: A) buy yen puts. B) buy yen calls. C) sell yen calls. D) sell yen puts.

Answer: A The exporter does not want to see the value of the yen fall. If she owns yen puts and the yen does fall, her profit on the puts would help compensate for the decrease in the value of the yen. Selling yen calls would also provide protection if the yen fell in value, but only to the extent of the premium received. Exporters buy puts in order to hedge; importers buy calls on the foreign currency to hedge.

An investor with no other positions buys 1 DWQ Jun 60 call at 3.50. If the investor exercises the call when the stock is trading at 68 and immediately sells the stock in the market, what is the investor's profit or loss? A) $450 profit. B) $350 profit. C) $350 loss. D) $450 loss.

Answer: A The investor exercised the right to buy the stock for 60 and can sell the stock in the market for 68 for an $8 per-share gain. The gain of 8 minus the premium of 3.50 gives the investor a profit of 4.50 (4.50 × 100 = $450).

A customer establishes the following positions: Buy 100 JMB at 28 Buy 1 JMB Dec 25 put at 2 What is the maximum potential loss? A) 500. B) 200. C) 2800. D) 3000.

Answer: A The investor loses money on the long stock position when the market value falls. With the purchase of the put, the investor can sell the stock for no less than the strike price, but also loses the premium. In this example, the investor loses a maximum of $3 on the stock (28 − 25) plus the premium of $2, for a total loss of $500 on 100 shares.

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) gain of $100. B) loss of $400. C) gain of $400. D) loss of $100.

Answer: A 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).

A customer writes 2 ABC July 15 puts at 2 when ABC is 14. If the contracts are closed at a premium of 4 when ABC is 13, the customer has a: A) $400 loss. B) $200 gain. C) $400 gain. D) $200 loss.

Answer: A The investor receives $400 in premiums (2 × $200) and pays $800 to close out the options (2 × $400), resulting in a net loss of $400 ($800 − $400).

A call is in-the-money when the market price of the underlying stock is A) equal to the strike price . B) less than the strike price. C) more than it was at the previous day's close. D) more than the strike price.

Answer: D Call options are in-the-money whenever the market price of the stock is greater than the strike price.

An investor who believes the U.S. dollar will strengthen against the Canadian dollar should profit from which of the following strategies? Buying puts on the Canadian dollar. Writing puts on the Canadian dollar. Writing a straddle on the Canadian dollar. Establishing a call credit spread on the Canadian dollar. A) I and IV. B) I and III. C) II and IV. D) III and IV.

Answer: A The investor who is bearish on the Canadian dollar should buy puts, write calls, and call spreads. Short straddles pay off when the market does not move either way.

All of the following are credit spreads EXCEPT A) buy 1 ABC Jul 50 call; write 1 ABC Jul 60 call B) write 1 ABC Nov 35 put; buy 1 ABC Nov 30 put C) buy 1 ABC Apr 40 call; write 1 ABC Apr 30 call D) buy 1 ABC Jan 50 put; write 1 ABC Jan 60 put

Answer: A The lower the strike price is, the more expensive the call premium for the option will be. The investor has purchased the option with the lower strike price so this is a debit spread. With puts, the higher the strike price is, the more expensive the option premium will be.

An investor opens the following position: Write 1 CDE Oct 30 call at 3.30 Buy 1 CDE Oct 40 call at .10. The maximum gain is: A) 320. B) 680. C) 1000. D) unlimited.

Answer: A The maximum gain on a credit spread is the net credit received (3.30 − .10 = 3.20 × 100 shares = $320).

An investor opens the following position: Buy 1 COD Jan 40 put at 6.50 Write 1 COD Jan 30 put at 2.10 His maximum loss is: A) 440. B) 560. C) 2100. D) 2600.

Answer: A The maximum loss on a debit spread is the net debit.

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

Answer: A 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.

If MCS is trading at 43 and the MCS Apr 40 call is trading at 4.50, what is the intrinsic value and the time value of the call premium? A) Intrinsic value 3; time value 1.50. B) Intrinsic value 4.50; time value 0. C) Intrinsic value 3; time value 4.50. D) Intrinsic value 1.50; time value 3.

Answer: A The option is in-the-money by 3 points (the strike price on the call is 40 and the market price is 43). This sets a minimum premium of $3 per share. Since the actual premium is 4.50, the balance of 1.50 represents time value.

Which of the following terms is synonymous with an option's market value? A) Premium. B) Strike price. C) Exercise price. D) Multiplier.

Answer: A The premium is the cost or price at which the option can be bought or sold in the market. The strike price or exercise price is the cost to exercise the option, while the multiplier indicates contract size.

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

Answer: A The purchase of a put limits the downside risk to the difference between the stock price and the put's strike price.

A stock selling for $62 is expected to decline temporarily in price, but the long-term trend is favorable. To take advantage of the temporary decline and generate income, the stockholder should: A) sell a call. B) sell a put. C) buy a call. D) buy a put.

Answer: A The sale of a call allows the investor to collect premiums. Because he owns the stock, the option is covered and no margin is required. Alternatively, the investor could buy a put to move more in-the-money as the stock price falls temporarily. He could later liquidate the put at a profit, but buying a put would not generate income.

Which of the following listed option positions is most unsuitable for a customer whose investment objectives include minimal risk? A) Short call. B) Short put. C) Long put. D) Long call.

Answer: A The sale of the call option burdens the investor with unlimited upside potential risk.

If XYZ stock is trading at 25.75 and XYZ Jul 25 calls are trading at a premium of 2, what is the time value of the Jul 25 calls? A) 125. B) 0. C) 75. D) 200.

Answer: A The time value is the premium minus the intrinsic value. The premium is 2 (or $200), and the intrinsic value is $75 ($200 − $75 = $125).

If a customer buys 100 shares of MTN at 60, buys an MTN 60 call at 3, and buys an MTN 60 put at 3, the investor's maximum gain would be: A) unlimited. B) 600. C) 5400. D) 6000.

Answer: A There is no limit to how high a stock's price can rise. Since this investor owns both the stock and an option to buy, the potential for gain is theoretically unlimited.

An investor is short stock at 60. The current market price of the stock is 35, and he anticipates it will continue to decline. If he thinks the price will rise temporarily and if he does not wish to close out his short position, his best strategy to prevent a loss would be to: Buy an XYZ 35 call. Sell an XYZ 35 call. Buy an XYZ 35 put. Sell an XYZ 35 put. A) I or IV. B) I or III. C) II or III. D) II or IV.

Answer: A This client is temporarily bullish on the stock, but, in the long term, feels that it will continue to decline so the short stock position is to be maintained. If the client is correct, a near-term rise in the price of XYZ will cause the long 35 call to be in the money and the investor can sell the call at a profit. Likewise, the short 35 put will be out of the money and will expire with the investor earning the premium.

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) loss of $1,050. B) gain of $450. C) loss of $450. D) gain of $1,050.

Answer: A 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.

An investor believes that the U.S. dollar will rise in value against the British pound. To profit with limited risk, which of the following foreign currency option transactions would you recommend? A) Buy British pound puts. B) Buy British pound calls. C) Sell British pound calls. D) Sell British pound puts.

Answer: A This investor should buy puts on the British pound to lock in the highest possible price at which to sell pounds. Any answer must be framed in terms of the British pound because there are no listed options on the U.S. dollar.

If an investor buys 1 TIP Jul 60 call at 4 and sells 1 TIP Jul 50 call at 8.50, what will be the investor's overall net profit or loss if both calls expire unexercised? A) $450 profit. B) $1,250 loss. C) $450 loss. D) $1,250 profit.

Answer: A This is a credit call spread because the larger premium of the two options is associated with the short call. The best possibility for this investor is expiration, when the maximum gain is realized. The maximum gain on a credit spread is the net credit. In this example, the investor paid 4 and received 8.50 for a net premium and maximum gain of 4.50.

If a customer writes 2 ABC Feb 90 puts at 8 and buys 2 ABC Feb 80 puts at 2, which of the following statements are TRUE? The spread is bullish. The spread is bearish. The breakeven point is 84. The breakeven point is 86. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: A This is a credit put spread (the net credit being 6 points per share) in which the breakeven point is calculated by subtracting the net premium (debit or credit) from the higher strike price (90 - 6 = 84). A credit put spread is like the net sale of a put, and buying the lower strike price in any spread (put or call) is bullish.

What is the breakeven point on the following position? Buy 1 CDE Apr 30 put at 3.10. Write 1 CDE Apr 35 put at 5.85. A) 32.25. B) 30.1. C) 32.75. D) 33.1.

Answer: A This is a put spread established at a credit of 2.75. To find the breakeven point on a put spread, subtract the net premium from the higher strike price (in this case, 35 − 2.75 = 32.25).

If a customer writes 1 ABC Jan 35 call at 13.50 and 1 ABC Jan 55 put at 12.50 when ABC is trading at 45, excluding commissions, this position will be profitable if ABC is: above 29. below 29. above 61. below 61. A) I and IV. B) I and II. C) II and III. D) III and IV.

Answer: A This is a short in-the-money combination. To compute the breakeven points, add the combined premiums (26) to the strike price of the call and subtract the combined premiums from the strike price of the put. The breakeven points are 61 (35 + 26) and 29 (55 − 26). With a short combination like a short straddle, the customer makes money if the stock stays inside the breakeven points.

If a customer bought a put option and the underlying security declined, the put would probably: A) be exercised. B) decline in value. C) not be exercised. D) be worthless.

Answer: A This is exactly what most put option buyers are looking for: they want the stock to go down. Since the market price of the stock declining would cause the option to be in-the-money, the investor would either exercise his option or sell it.

A customer writes 1 OEX (S&P 100) June 820 call at 13 and buys 1 OEX June 830 call at 6, when the index is trading at 826. The breakeven point is: A) 827. B) 823. C) 826. D) 830.

Answer: A To compute the breakeven point for a call spread, add the net premium (debit or credit) to the lower strike price (a net credit of 7 plus 820 equals a breakeven point of 827). This is a bear spread. The customer will profit if the index is below 827 at expiration.

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) 300. B) 225. C) 250. D) 275.

Answer: A 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.

The premium on the XYZ Jan 30 calls is 3 - 3.15, while the premium on the XYZ Jan 30 puts is quoted at 2.25 - 2.35. A customer establishing a short straddle receives total premiums of: A) 525. B) 537. C) 545. D) 550.

Answer: A To establish a short straddle, the customer sells a call and a put at the bid price. The premiums received are $300 for the call and $225 for the put, for a total of $525.

If a U.S. corporation exports machine tools to Switzerland and will be paid in Swiss francs, to protect against foreign-exchange risk it should: A) buy SF puts. B) buy SF calls. C) sell SF calls. D) sell SF puts.

Answer: A To hedge, exporters buy puts on foreign currency. The U.S. exporter's risk is that the value of the Swiss franc will be falling against the U.S. dollar. Owning the SF puts would benefit the U.S. corporation should this risk occur.

A customer sells short 1,000 ZOO at $30 per share. If the ZOO stock declines to $25 per share and the customer is worried the stock may reverse its trend, what should the customer do? A) Buy 10 ZOO calls. B) Buy 10 ZOO puts. C) Write 10 ZOO calls. D) Write 10 ZOO puts.

Answer: A To protect the profit on the short stock position, the customer must be able to buy stock at the existing low price if the market moves up. By purchasing calls (say, at a $25 strike price), the customer can capture existing profit by exercising and buying stock at $25, regardless of how high the market moves.

All US exchange listed foreign currency options are settled in the underlying foreign currency are settled in cash (US dollars) expire on the third Friday of the expiration month expire on the Saturday following the third Friday of the expiration month A) II and IV B) I and III C) I and IV D) II and III

Answer: A US exchange listed currency options are settled in cash (US dollars) and expire on the Saturday following the third Friday of the expiration month, just like equity options do.

A customer creates a long straddle by buying 5 ABC Nov 50 calls and 5 ABC Nov 50 puts paying premiums of $3,750. If ABC is at 56.50 at expiration, the customer has a: A) loss of $500. B) gain of $500. C) gain of $1,000. D) loss of $1,000.

Answer: A While the puts would expire, the customer may close out the calls by selling them at 6.50 (56.50 − 50) for $3,250 (6.50 × 5 × $100). The result is a loss of $500 ($3,750 − $3,250).

An option investor might do all of the following EXCEPT: A) hedge a long stock position with a short put. B) make a closing purchase. C) make an opening sale. D) hedge a short stock position with a long call .

Answer: A Writing a put does not reduce the risk of a long stock position. The short put creates an obligation to purchase additional shares if the put is exercised (which will happen if the stock falls). A long call is an effective hedge against a short stock position.

In early April, a customer buys 1 XYZ Oct 60 call for 9 and sells 1 XYZ Jul 70 call for 4. Before the calls expire, the customer may realize a pretax profit if the: A) spread narrows to less than $5. B) spread widens to more than $5. C) price of XYZ decreases. D) price of XYZ stays the same.

Answer: B This is a debit spread of $5 (net debit). Debit spreads are profitable if the spread widens between the premiums.

Which of the following strategies would be considered most risky in a bull market? A) Writing naked calls. B) Buying calls. C) Writing naked puts. D) Buying a put.

Answer: A 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.

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

Answer: A Yield based options settle in cash if the option is exercised. The writer must deliver the in-the-money amount in cash.

Which of the following securities underlies a yield-based option? A) Treasury securities. B) Income bonds. C) Debentures. D) Revenue bonds.

Answer: A Yield-based interest rate options are based on the yields of Treasury bills, notes, and bonds.

Yield-based options expire on the Saturday: A) following the third Friday of the month. B) preceding the third Wednesday of the month. C) following the third Wednesday of the month. D) preceding the third Friday of the month.

Answer: A Yield-based options expire like stock options; on the Saturday following the third Friday of the month.

An investor writes 1 IBS 280 put for 16.60. The position is closed and the put is bought for its intrinsic value when IBS is trading at 265.25. The investor realizes a: A) $145 profit. B) $185 profit. C) $235 loss. D) $185 loss.

Answer: B The opening sale of the IBS put was made for 16.60, and the closing purchase was made for the intrinsic value of 14.75. The put's intrinsic value is determined by how far the stock's market price is below the strike price. (In this case, 280 minus 265.25.) 16.60 − 14.75 = 1.85 × 100 shares = $185.00. The investor profits because the sale's proceeds exceed the purchase price.

If a customer is long 10 ABC Jul 50 calls at 4.50, the contracts give the holder the: A) obligation to sell stock. B) right to buy stock. C) right to sell stock. D) obligation to buy stock.

Answer: B A long call gives the holder the right to buy stock.

An investor establishes the following positions: Long 1 XYZ Apr 45 call at 3.50 Long 1 XYZ Apr 45 put at 2.75 The investor's strategy will realize a gain if XYZ trades above: A) 48.5. B) 51.25. C) 45 D) 47.75.

Answer: B A long straddle is profitable if the stock price moves sharply in either direction. In this example, the investor paid a premium of 6.25 to establish the straddle. To realize a gain, the stock must either fall below the strike price minus the combined premium (45 − 6.25 = 38.75) or rise above the strike price plus the combined premium (45 + 6.25 = 51.25).

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

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

If a customer is long 300 shares of ABC, and writes 5 calls against the position, this is an example of a: A) straddle. B) ratio write. C) partial write. D) spread.

Answer: B A ratio write involves writing more options than the customer has stock to cover.

Which of the following positions would create the most risk for an investor? A) Buy 100 shares of SSS and sell 1 SSS call. B) Sell short 100 shares of SSS and sell 1 SSS put. C) Sell short 100 shares of SSS and buy 1 SSS call. D) Buy 100 shares of SSS and buy 1 SSS put.

Answer: B A short sale of SSS stock has unlimited loss potential. Selling a put obligates the customer to buy the stock at the strike price in return for premium. A short sale coupled with a sale of a put is equivalent to selling an uncovered call and creates the most risk.

European-style foreign currency options can be exercised at any time only be exercised at expiration be traded at any time only be traded at expiration A) II and IV B) II and III C) I and III D) I and IV

Answer: B All US exchange listed currency contracts are European-style exercise, which can only be exercised at expiration. However, positions can be closed at any time until expiration.

In which of the following strategies would the investor want the spread to widen? Buy 1 RST May 30 put; write 1 RST May 25 put. Write 1 RST Apr 45 put; buy 1 RST Apr 55 put. Buy 1 RST Nov 65 put; write 1 RST Nov 75 put. Buy 1 RST Jan 40 call; write 1 RST Jan 30 call. A) III and IV. B) I and II. C) I and IV. D) II and III.

Answer: B An investor wants a debit spread to widen (choices I and II). As the difference between premiums increases, so does potential profit because the investor may sell the option with the higher premium and buy back the option with the lower premium. With credit spreads, investors profit if the spread between the premiums narrows.

Which of the following investors will sell stock if an option is exercised? Owner of a call. Owner of a put. Writer of a call. Writer of a put. A) III and IV. B) II and III. C) I and II. D) I and IV.

Answer: B An owner of a put and writer of a call will sell stock if an option is exercised. Call buyers have the right to buy, and call writers are obligated to sell; put buyers have the right to sell, and put writers are obligated to buy.

What is the breakeven point on the following position? Buy 1 QRS Jan 40 call at 2.35 Write 1 QRS Jan 45 call at .85 A) 43.5. B) 41.5. C) 41.75. D) 43.25.

Answer: B Because this is a call spread, the breakeven point is calculated by adding the net premium of 1.50 to the lower strike price (40 + 1.50 = 41.50).

If a ROP is asked to approve a discretionary order to buy 1 XYZ Oct 60 put and sell 1 XYZ Oct 55 put for a net debit of $5, he should: A) approve the order in writing. B) not approve the order. C) approve the order if the customer has sufficient funds in his accounts. D) obtain the best execution for the order.

Answer: B Because this is a debit spread, the maximum gain occurs if both sides are exercised. If this occurs, the investor earns $5 (buy stock at 55 when the short put is exercised and sell stock at 60 by exercising the long put). Because the net premium paid for the spread is $5, there can never be any gain. This spread is not economical.

If XYZ closed at 41.10 and the XYZ Feb 50 calls closed at .35, the calls are: A) in-the-money. B) at the money. C) at parity. D) out-of-the-money.

Answer: D Call options are out-of-the-money when the market price is below the strike price.

In a strong bull market, which of the following positions has the potential for the highest percentage gain? A) Selling short. B) Holding calls. C) Writing puts. D) Holding stocks.

Answer: B Both a long call and a long stock position are profitable in a rising market. However, because options use leverage, the profit relative to the money invested is larger with option positions. A put writer also profits in a rising market, but only by the amount of the premium. A short seller loses money if the stock rises.

If a customer with no other position sells 1 KLP Jul 80 call for 10 and buys 100 shares of KLP stock for $85 per share, he will break even when KLP stock is trading at: A) 95. B) 75. C) 70. D) 90.

Answer: B Breakeven for a covered call writer is the purchase price less premiums received. In this case, breakeven is 85 minus 10, or $75 per share; below $75, the customer loses money.

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

Answer: B Breakeven for the buyer of a put is the strike price of the option minus the premium paid for the option.

An investor buys 200 shares of ABC at 66.50 and writes 2 ABC Feb 70 calls at 1.50. The customer will profit or break even if, at expiration, the stock is at any of the following prices EXCEPT: A) 67.5. B) 64.5. C) 65.5. D) 66.5.

Answer: B Breakeven is 65 (66.50 − 1.50); above 65, the customer makes money. If the stock is at 64.50 at expiration, the customer has a $100 loss.

If a customer buys 2 Canadian dollar 78 calls and writes 2 Canadian dollar 80 calls, this position is a A) horizontal call spread. B) bull call spread. C) diagonal call spread. D) credit call spread.

Answer: B Bull positions in options spreads are established by buying the option with the lower strike price.

If a customer believes the price of ABC is going to fall, which of the following option strategies would be appropriate? Buy calls on ABC. Write calls on ABC. Buy puts on ABC. Write puts on ABC. A) II and IV. B) II and III. C) I and II. D) I and IV.

Answer: B Buying puts and writing calls are bearish strategies.

An investor has a diversified portfolio of common stock with a market value of $1.7 million and a beta of 1.20. If the OEX (S&P 100) is currently quoted at 680, to protect the portfolio against a decline in value, the investor's best strategy is to buy: A) 25 puts. B) 30 puts. C) 25 calls. D) 30 calls.

Answer: B Buying puts is the most effective strategy to hedge the risk of decline in a stock portfolio's market value. To determine the number of option contracts necessary to hedge, divide the portfolio value ($1.7 million) by the market value of the index (68,000). Multiply the result (25) by the beta of 1.20. The result is 30 contracts.

An investor holding a broad based diversified portfolio of stocks feels the market, which has slowed recently, may be poised for a brief fall before it continues an upward trend long-term. The investor does not want to incur the cost of selling a portion of their holdings nor the risk of mistiming the market. A possible strategy would be to: A) sell an index call option. B) buy an index put option. C) sell an index put option. D) buy an index call option.

Answer: B By not liquidating the client can benefit if the market increases. Because the portfolio is broad based and diversified, it should move with the market. An index option also moves with the market, and therefore, would be a good hedge vehicle. A long put should be used because it will increase in value if the market should decline.

Which of the following is NOT an advantage of buying listed call options as compared to buying the underlying stock? A) Buying a call allows greater leverage than buying the underlying stock. B) The call has a time value beyond an intrinsic value that gradually dissipates. C) Buying a call would require a smaller capital commitment. D) Buying a call has a lower dollar loss potential than buying the stock.

Answer: B Call options allow greater leverage than buying the underlying stock and the capital requirements are smaller, allowing for a smaller loss potential. The fact that options expire (i.e., have a time value that erodes as the option nears expiration) is a disadvantage of options. Stock purchases have no time value component-there is no expiration and no resulting value erosion.

All of the following will cover a short call EXCEPT: A) a long position in the underlying stock. B) cash equal to the aggregate exercise value. C) an escrow receipt for the stock. D) a long call with a lower strike price and later expiration.

Answer: B Cash never covers a short call because the cost to purchase the stock in the market for delivery at the strike price is unknown. If assigned, the customer must sell (deliver) at the strike price.

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

Answer: B 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.

A customer buys an Oct 79.50 foreign currency call on the Australian dollar. The Australian dollar spot price is 89.73, and the the option contract size is 10,000 Australian dollars. If the option contract is offered at 11, what was the customer's total premium paid for the contract? A) 11000 B) 1100 C) 8973 D) 10000

Answer: B Currency options are quoted in U.S. cents per dollar and one point equals $100. A quote of 11.00 is equal to $1,100 per contract.

If your customer owns 100 shares of a volatile stock and wants to limit downside risk, you may recommend: A) shorting the same stock. B) buying puts. C) writing calls and selling puts. D) buying calls.

Answer: B Downside risk is reduced by purchasing a put with a strike price at or close to the stock's purchase price. Should the stock decline below the strike price, the investor can exercise the put at the strike price. Selling put options will increase the downside risk. Buying calls is a bullish strategy that increases downside risk. Shorting stock will lock in the current price but will limit upside potential.

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) 1800. C) 200. D) 700.

Answer: B 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.

How many business days after an index option is exercised should a cash settlement occur? A) 5. B) 1. C) 2. D) 3.

Answer: B Exercised stock index options settle on the next business day.

Which of the following would protect a short May 50 put? A) Long June 45 put. B) Long June 55 put. C) Long April 55 put. D) Long April 45 put.

Answer: B For a long put to cover a short put, it must have the same or higher strike price and the same or longer expiration. This ensures the investor may sell the stock without financial loss if the short put is exercised and he is forced to buy.

Trading in foreign currency options would probably be an appropriate hedging tool for a bank dealing in international finance. multinational corporation. trader holding cash reserves in both U.S. dollars and Swiss francs. firm in the import and export business. A) II and IV. B) I, II, III and IV. C) I and II. D) I, III and IV.

Answer: B Foreign currency options would be useful to hedge the accounts of each of the entities listed. Generally, any time the potential need to deliver a foreign currency or accept payment of a foreign currency can be anticipated, currency options are a useful hedge.

A customer wrote 10 KLM Jun 80 calls for a premium of 4.75 at a time when the market value of KLM was 81.75. What is his gain or loss if he now closes out his positions at 2.12? A) A $4,750 loss. B) A $2,630 gain. C) A $2,630 loss. D) A $4,750 gain.

Answer: B If the customer sold at 4.75 and purchased at 2.12, the customer nets 2.63, which is multiplied by 100 to yield a $263 gain per contract: 10 × $263 = $2,630 total gain.

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 put. C) Short call. D) Short straddle.

Answer: B 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.

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? A) 7. B) 11. C) 0. D) 4.

Answer: B 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.

Which of the following statements regarding stock index options are TRUE? Trades are settled the next business day. Trades are settled on the third business day. Exercise settlement involves the delivery of stock. Exercise settlement involves the delivery of cash. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B Index option trades settle the next business day and cash is delivered upon exercise of the option. Exercised index options also settle next business day.

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

Answer: B LEAPS are available on both individual stocks as well as indexes.

Securities options may be best described as: A) futures. B) derivatives. C) roll ups. D) forwards.

Answer: B Options are a derivative because they get their values from the underlying instrument.

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

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

Buying a put option on a security he holds allows an investor to participate in additional gains if the security continues to increase in price. buy more stock if he exercises the put. protect a profit on his current stock position. receive the premium for the purchase of the put. A) III and IV. B) I and III. C) I and II. D) II and III.

Answer: B 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.

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? A) 450. B) 1050. C) 150. D) 350.

Answer: B 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.

If the S&P 500 Index closed at 350 on the day your customer purchased a 355 put on the Index for $500, which of the following would best describe your customer's position? A) Out-of-the-money. B) Breakeven. C) Even money. D) At-the-money.

Answer: B Remember that for a put option, subtract the premium from the strike price to find the breakeven point. 355 − 5 = 350. Since the S&P Index closed at 350 on the day, the customer's position is at breakeven.

An options trader establishes the following positions: Long 10 ALF Apr 40 calls at 6 Short 10 ALF Apr 50 calls at 2 What is the client's maximum gain and loss per share? A) Gain 4, loss 2. B) Gain unlimited, loss 6. C) Gain 6, loss 4. D) Gain 2, loss 6.

Answer: C The gain is 6 (between 44 and 50). If the stock declines, both options will expire for a loss of 4 (6 − 2).

With the same dollar amount either paid or received, which of the following strategies can cause an investor to experience the greatest loss? A) Buying a straddle. B) Selling a naked call option. C) Selling a covered put option. D) Selling a naked put option.

Answer: B Selling a naked call option has an unlimited loss potential. If the holder of the option exercises, the call writer is obligated to deliver the shares of stock at the strike price. The naked call writer does not own the stock and must purchase the shares in the open market in order to fulfill the obligation.

A customer who owns a portfolio of blue-chip stocks believes the securities will provide long-term appreciation, but fears that the market will decline over the short term. Which index options strategy should protect against the expected decline and allow the customer to generate additional income? A) Sell covered puts. B) Sell covered calls. C) Buy puts. D) Buy calls.

Answer: B Selling calls will generate income and protect the downside to the extent of the premiums received.

If a customer sells short 100 XYZ at 79 and simultaneously writes 1 XYZ Jan 80 put at 5, the maximum gain potential is: A) unlimited. B) 400. C) 500. D) 600.

Answer: B Short stock combined with a short put is an income strategy that carries unlimited loss potential. Although gain will occur if the stock moves downward, the customer wrote an in-the-money put that will be exercised, forcing the customer to buy stock at 80 for a $100 loss on the stock shorted at 79. However, the customer received $500 in premiums, resulting in an overall gain of $400. Breakeven for short stock-short put is short sale price plus premium. In this case, breakeven is 84 and maximum gain is 4 points, from 84 to 80.

If a customer buys 100 XYZ at 52.50 and buys 1 XYZ Aug 50 put at 1.50, what is the customer's maximum possible loss? A) Unlimited. B) 400. C) 5250. D) 5400.

Answer: B Stockholders often buy puts to protect long positions. In this case, if the stock falls below 50, the investor will exercise the right to sell it at 50. The loss on the stock is limited to 2.50, which, combined with the premium paid of 1.50, results in a $400 loss.

If the Swiss franc is trading at .69, and a customer buys 1 Sep SF 70 put and writes 1 Sep SF 65 put, this position is a: A) bull spread. B) bear spread. C) diagonal spread. D) calendar spread.

Answer: B The 70 put is dominant because it will have a higher premium than the 65 put. Buying puts is bearish; this is a debit put spread.

ALFA closed at 37.50, the ALFA Jan 35 calls closed at 3.50, and ALFA Feb 35 calls closed at 4.60. What is the difference in the time values between the two options? A) 37.5. B) 1.1. C) 2.5. D) 35

Answer: B The January premium is 3.50 and the February premium is 4.60 (the difference is 1.10). Each option is in the money by 2.50.

If a Japanese exporter wants to hedge a recent sale of stereo equipment to a U.S. buyer, and the exporter will be paid in U.S. dollars upon delivery of the goods, the best hedge would be to: A) buy Japanese yen puts. B) buy Japanese yen calls. C) sell Japanese yen calls. D) sell Japanese yen puts.

Answer: B The Japanese exporter will be paid in U.S. dollars upon delivery of the equipment. He would be adversely affected if the dollar dropped in value in relation to the yen. To protect his position he should buy calls on his own currency, the yen. Then, if the yen appreciates, his loss on the dollar is offset by his gain on the calls. Exporters buy puts on foreign currency to hedge, but there are no options on the U.S. dollar. The next best strategy is to buy calls on the home currency.

A customer is long an ABC Apr 40 call and is also short an ABC Jul 40 call. Which of the following best describe his position? Bullish. Bearish. Calendar spread. Vertical spread. A) II and IV. B) II and III. C) I and III. D) I and IV.

Answer: B The July call will have a higher premium than the April call because it has more time value. Since the customer is selling the call with the higher premium, he is counting on the July call to go unexercised, which would allow him to keep the premium as a profit. That means the market value of the underlying security must either stay the same or decline. This customer's position is therefore bearish. Since the options expire in different months, the trade is a calendar spread.

The breakeven point for covered call writers is: A) strike price less premiums. B) cost of stock less premiums. C) cost of stock plus premiums . D) strike price plus premiums.

Answer: B The breakeven point for an investor who owns the underlying stock and writes a call is the cost of that stock less the premium received from the sale of the call.

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) 9225. B) 6700. C) 3350. D) 9150.

Answer: B The client purchased 10 calls at 6.70 for a total of $6,700. The margin requirement is 100% of the premium.

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.

Answer: B The contracts will not be exercised if options expire at the money. Therefore, writers will show a profit but buyers will not.

A customer buys 1 XYZ Aug 60 call at 4 and 1 XYZ Aug 60 put at 2 when XYZ is at 61.25. If the stock rises to 68 and the customer lets the put expire and closes out the call at intrinsic value, the result is a: A) loss of $600. B) gain of $200. C) loss of $200. D) gain of $600.

Answer: B The customer has established a long straddle. To determine profit or loss, compute the breakeven points by both adding and subtracting the combined premiums (6 points) from strike (the breakeven points are 54 and 66). Because the customer profits if the stock moves outside these points, at 68, the customer has a 2-point ($200) gain.

A customer is short 100 XYZ shares at 26 and long 1 XYZ 30 call at 1. What is the maximum potential gain for the customer? A) 5200. B) 2500. C) 500. D) 2600.

Answer: B The customer has hedged his short stock position from a market advance by buying the call. If the market falls, the investor can make a maximum of $26 per share if the stock price falls to zero, less the premium of 1 paid to buy the call, for a maximum gain of $2,500 (26 − 1 = 25).

If a customer is short 100 XYZ shares at 54 and long 1 XYZ 55 call at 2, what is the maximum potential loss? A) Unlimited. B) 300. C) 100. D) 200.

Answer: B The customer has protected his short stock position from a market advance by purchasing the call. If the market rises, the call is exercised, allowing the customer to buy stock at the options strike price of 55 to cover the short position. Therefore, the most the customer can lose is $100 on the stock position (the difference between the option strike price and short sale price), plus the premium paid for the option ($100 + $200 = $300).

A customer sells short 100 shares of XYZ at 58 and buys 1 XYZ Jan 60 call for 3. If the stock price falls to $52, the customer buys back the stock and closes the option at 1 for a A) loss of $400. B) gain of $400. C) gain of $300. D) loss of $300.

Answer: B The customer made $600 on the short stock position ($58 to $52) and lost $200 on the call (bought for 3, sold at 1). Overall, the gain is $400.

In a single day, a customer purchases 15 ACM Sep 50 puts at 6 and 15 ACM Sep 50 calls at 1. The customer would profit from the positions if ACM traded: A) between $43 and $57. B) either below $43 or above $57. C) between $38 and $52. D) either below $38 or above $52.

Answer: B The customer paid $6 for the Sep 50 puts and $1 for the Sep 50 calls. A long straddle is profitable on the call side if the price rises above the strike price plus the combined premiums paid ($57). On the put side, it is profitable if the price falls below the strike price minus the combined premiums paid ($43).

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 a net debit of 9, the customer has: A) a loss of $300. B) a gain of $300. C) a gain of $100. D) a loss of $100.

Answer: B 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.

An investor writes 1 TCB 320 put for 21.35 and the stock closes at 304.50. He makes a closing transaction at the intrinsic value and the result is a: A) $585 loss. B) $585 profit. C) $155 profit. D) $155 loss.

Answer: B The investor opened the position and received 21.35 for selling the option. He closed the position by buying the option at its intrinsic value, which equals the difference between the stock's market price and the option's strike price. In this example, 320 - 304.50 equals an intrinsic value of 15.50. The investor's gain is the difference between the sale price of 21.35 and the purchase price of 15.50, which equals 5.85, or $5.85. His profit is $5.85 multiplied by 100, or $585.00.

A customer establishes the following positions: Long 1 ABC Jun 25 call at 2 Long 1 ABC Jun 25 put at 2 At expiration, the position is profitable if the stock price is above 21. below 21. above 29. below 29. A) II and IV. B) II and III. C) I and III. D) I and IV.

Answer: B The investor purchased a long straddle (both a call and put with the same strike prices and expiration months). While straddle investors are uncertain about the direction of the market, long straddles require substantial price movement (volatility) for profit because the two premiums paid must be recovered. In this example the breakeven of the call is found by adding the total premiums of 4 to the call strike price of 25 (25 + 4 = 29). The breakeven of the put is found by subtracting the total premiums of 4 from the put strike price of 25 (25 − 4 = 21). The market must either move up by 4 (total premiums paid) or down by 4 to be at breakeven. For profit, the market must be above or below the breakeven points.

An investor establishes the following position: Long 1 XYZ Jan 50 put at 2 The maximum potential gain on the position is A) unlimited. B) 4800. C) 0. D) 200.

Answer: B 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).

If a customer buys 1 XYZ Aug 50 put at 1, and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58, the maximum potential gain is: A) 1500. B) 900. C) 600. D) 1100.

Answer: B The maximum gain on any credit spread is the net credit. In this case, $1,000 was received and $100 paid out, so the net credit is $900.

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

Answer: B 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.

In April, a customer buys 1 MCS Oct 50 call for 9 and sells 1 MCS Jul 50 call for 4. What will the customer's profit or loss be if he buys back the July call for $1 and sells the October call for $12? A) $100 loss. B) $600 profit. C) $600 loss. D) $100 profit.

Answer: B The net gain is $600 because the client paid a total of 10 (9 + 1) and received a total of 16 (12 + 4).

All of the following would affect option premiums EXCEPT the: A) time to expiration. B) the number of contracts a client is long or short. C) volatility of the underlying security. D) price of the underlying security.

Answer: B The number of contracts a client is long or short would not affect option premiums. The volatility of the stock, the price of the stock, and the time to expiration would all affect option premiums.

The manager of a portfolio that consists predominately of large- and mid-cap stocks could hedge against a market downturn and generate additional income by A) selling broad index puts. B) selling broad index calls. C) buying broad index calls. D) buying broad index puts.

Answer: B The only way to generate income through the use of options is to sell them. If one is concerned that the market may fall, selling calls is the appropriate strategy.

An investor with no other positions sells 1 ABC Jan 45 call at 2.50. If the option expires when the stock is trading at 44.50, what is the investor's profit or loss? A) $250 loss. B) $250 profit. C) $50 profit. D) $50 loss.

Answer: B The option expired because it was out-of-the-money. When the option expires, the writer profits by the amount of the premium received from the sale.

At expiration, the market price of the underlying stock is the same as the strike price of the option. Which of the following positions result in a profit? Short call. Long call. Short put. Long put. A) III and IV. B) I and III. C) I and II. D) I, II and IV.

Answer: B The option has no intrinsic value if the market price of the underlying stock is equal to the strike price of an option (put or call). If an option has no intrinsic value at expiration, it is theoretically worthless. If an option expires worthless, the writer profits.

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

Answer: B 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.

The derivative-based strategy known as portfolio insurance involves the: A) purchase of a call on the underlying security position. B) purchase of a put on the underlying security position. C) sale of a put on the underlying security position. D) sale of a call on the underlying security position

Answer: B The purchase of a put option to hedge the downside risk of an underlying security holding is called a protective put position one of many derivative-based strategies collectively known as portfolio insurance.

Which of the following can be advantages of buying an option? Leverage To position against a written option To limit risk. A) III only. B) I, II and III. C) I only. D) II and III.

Answer: B The purchase of an option allows an investor to speculate and fully participate in the price movement of 100 shares of stock at a fraction of the cost of the shares involved, thus leveraging his investment. When used to position against a written option, the purchase of an option will reduce the risk of loss involved with a single written option. Used in conjunction with a securities position, the purchase of an option can act as an insurance policy to reduce the risk of loss (hedging); therefore, options offer all of these advantages but only for a limited period of time.

Which of the following choices cover a short call? Long the stock. An escrow receipt for the stock. Long a call, same expiration or later, same strike price or less. Cash equal to the aggregate exercise price. A) II and IV. B) I, II and III. C) I, II, III and IV. D) III and IV.

Answer: B The seller of a call must deliver stock on exercise, so the shares of stock (or their equivalent) will cover the obligation. A long call with a lower or equal strike price (same or later expiration) would enable the seller to buy the shares needed to deliver. Cash equal to the exercise price is insufficient because the market price of the stock will be higher than the strike price if the contract is exercised. Cash never covers a short call.

The writer of a combination expects the market to be: A) volatile. B) stable. C) bullish. D) bearish.

Answer: B The writer, or seller, of a combination expects the market to be stable. The buyer of a combination expects the market to be volatile. Combinations and straddles are never bullish or bearish, as there are always both calls and puts involved in the strategy, which are both bullish and bearish. Remember, the definition of a combination is a put and a call on the same underlying security with the strike prices and/or the expiration months being different.

An investor owns $100,000 of convertible bonds with a conversion price of $50. By depositing these bonds into his account, how many covered calls could he write? A) None. B) 20. C) 50. D) 2000.

Answer: B These bonds are convertible into 20 shares for each $1,000, making a total of 2,000 shares. That's enough stock to cover 20 calls.

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: the difference between the premiums narrows to less than $8 the difference between the premiums widens to more than $8 both puts are exercised at the same time both puts expire unexercised. A) II and IV. B) II and III. C) I and III. D) I and IV.

Answer: B 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).

With ABC trading at 39, a customer buys 1 ABC March 40 call and sells 1 ABC March 35 call. A profit occurs if: the spread widens. the spread narrows. ABC declines sharply. both contracts are exercised. A) III and IV. B) II and III. C) I and III. D) II and IV.

Answer: B This investor established a credit spread because the premium he received for the 35 call is more than he will pay for the 40 call; a call with a lower strike always carries a higher premium. As a general statement, credit spreads are bearish, and are profitable if the spread narrows between the premiums or the contracts expire unexercised (this will happen if the stock falls).

If a customer buys 1 ABC Jan 60 put at 6 and writes 1 ABC Jan 75 put at 13, the maximum loss is: A) 1500. B) 800. C) 700. D) 900.

Answer: B This is a credit spread (more premium was received than was paid). The maximum gain to a seller is the premium received (net credit of 7). In a spread, the maximum gain plus the maximum loss equal the difference in strike prices (75 − 60 = 15). Therefore, 15 less the maximum gain of 7 equals the maximum loss of 8 multiplied by $100, or $800.

If a customer buys 1 OEX Feb 350 call at 5 and sells 1 OEX Feb 335 call at 16 when the underlying index is at 344, he will profit if the spread narrows. spread widens. underlying index does not change. underlying index rises in value. A) II and IV. B) I and III. C) I and IV. D) III and IV.

Answer: B This is a credit spread because the investor received more premium than was paid. Sellers profit if both contracts expire or the spread narrows. The breakeven point is 346 (335 + 11, the net premium) and because the spread is bearish, the customer profits if the index is below 346.

If a customer buys 1 XYZ Aug 50 put at 1, and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58, what is the maximum risk? A) 1500. B) 600. C) 100. D) 900.

Answer: B This is a credit spread. The maximum loss is the difference between the strike prices and the net credit. In this example, the strike price difference is 15 (65 - 50) and the net premium is 9 (10 − 1) or 15 − 9 = 6 × $100 = $600 maximum loss. Maximum gain is the net credit of $900.

If an investor buys a Jan 30 XYZ call for 4 and sells a Jan 35 call for 2, to become profitable, the spread between the prices of the two options must: A) fluctuate. B) widen. C) narrow. D) remain the same.

Answer: B This is a debit spread. A debit spread is profitable when the difference between the premiums widens. A debit spread is closed as a credit and, to be profitable, the credit must be larger than the opening debit.

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) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B 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 client writes 1 Dec 45 put and buys 1 Dec 60 put. This is a: bull spread. bear spread. debit spread. credit spread. A) II and IV. B) II and III. C) I and III. D) I and IV.

Answer: B This is a put debit spread, and bears buy puts. The 60 put is worth more because it has a higher strike price.

Long an ABC Apr 60 call and short an ABC Apr 70 call is a: A) net credit spread. B) net debit spread. C) straddle. D) calendar spread.

Answer: B This is a vertical spread, not a calendar spread. To determine whether it is a net credit or debit, look at the strike prices. For call options with the same expiry month, the lower strike price will always have a higher value. In this case, the investor is long the higher valued option, which gives a net outflow of cash to enter the entire position (more money was spent on the lower strike price call than received for the higher strike price call). Therefore, the investor has a net debit for his account.

A stock currently sells for $75 per share. If a put option on the stock has an exercise price of $70 and currently sells for $0.50, the put option is: A) at breakeven. B) out-of-the-money. C) at-the-money. D) in-the-money.

Answer: B This put option has a zero intrinsic value and is therefore out-of-the-money by the $5 difference by which the market price exceeds the strike price. A put option has intrinsic value or is in-the-money when the current market price of the underlying asset is less than the exercise price (in this example, $70).

The OEX index (Standard & Poor's 100) closes at 379.70, up .60 from the prior day's close. The holder of 10 in-the-money calls makes an unrealized gain of: A) 6000. B) 600. C) 6. D) 60.

Answer: B This unrealized gain is $600 (10 calls × .60 × $100 = $600).

If the strike price of a yield-based option is 62.50, this represents a yield of: A) 0.625. B) 0.0625. C) 0.000625. D) 0.00625.

Answer: B To calculate the percentage yield of the underlying Treasury security, divide the strike price by 10 (62.50 / 10 = 6.25%).

If a customer buys 1 OEX Feb 350 call at 5, then sells 1 OEX Feb 335 call at 16 when the underlying index is at 344, the breakeven point is: A) 342. B) 346. C) 339. D) 340.

Answer: B To determine a call spread, add the net premium to the lower strike price to find the breakeven point. The net premium is the difference between the premium paid (5) and the premium received (16), or 11 (335 + 11 = a breakeven point of 346).

Index options differ from stock options in which of the following ways? A) The expiration date is the Saturday following the third Friday of the expiration month. B) The exercise settlement is in cash. C) They are subject to closing purchases as well as closing sales. D) The trade settlement date is the next business day. .

Answer: B When an index option is exercised, cash is paid to the option holder for the amount in-the-money. In contrast, exercising a stock option involves delivering the underlying stock. Both index options and stock options have the same expiration date and the same trade settlement date. Closing transactions can be purchases or sales for any option, regardless of the underlying asset.

A customer buys an Oct 76 put on the Swiss franc for a premium of 5. The franc closes at 74. Which of the following is TRUE? A) It has no time value. B) It has intrinsic value. C) It is out-of-the-money. D) It is at-the-money.

Answer: B When the CMV is below the strike price, puts are in-the-money. Therefore, they have intrinsic value.

An investor with no other positions sells 1 ABC Dec 55 call at 4.50. If the call is exercised when the stock is trading at 57.25, what is the investor's profit or loss? A) $275 loss. B) $225 profit. C) $225 loss. D) $275 profit.

Answer: B When the call is exercised, the investor is forced to buy the stock in the market for 57.25 and sell it to the owner of the call for 55, for a 2.25-point loss. The investor's premium of 4.50 minus the loss of 2.25 gives the investor a profit of 2.25 (2.25 × 100 = $225). If a call is exercised, a writer must sell (deliver) his shares at the strike price.

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) $700 loss. B) $700 profit. C) $175 profit. D) $175 loss.

Answer: B 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.

An investor buys 100 shares of QRS stock at 60, and writes 1 QRS 60 call at 4 and 1 QRS 60 put at 5. If QRS stock is trading at $74 on the expiration date, the investor realizes a profit of: A) 500. B) 900. C) 100. D) 400.

Answer: B With QRS trading at 74 on the expiration date, the QRS 60 call will be exercised while the QRS 60 put will expire. The investor originally bought the stock in the market at 60 and wrote the two options that generated a $900 premium. Because the customer sells his stock at $60, his $900 premium is the profit.

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

Answer: C To profit on a long call, the market price must exceed the strike price plus the premium paid (the breakeven point).

An investor buys a yield-based Sept 70 call on a 30-year T-bond for a premium of 2.50. At expiration, if the yield on the most recently issued T-bond is 7.95%, what is the investor's gain or loss? A) $950 loss. B) $950 gain. C) $700 gain. D) $700 loss.

Answer: C A September 70 call means that the holder is buying a 7% yield. The investor can close the option at its intrinsic value: (7.95 − 7.00 = 0.95; 0.95 × 10 × $100 = $950 received upon close). Subtract $250 premium paid for a total profit of $700.

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 has no time value. C) The contract has intrinsic value. D) The contract is out-of-the-money.

Answer: C 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).

Which term describes the following position? Write 1 DOH Jan 30 call. Write 1 DOH Jan 40 put. A) Diagonal spread. B) Short straddle. C) Short combination. D) Price spread.

Answer: C A combination is composed of a long call and long put, or a short call and a short put each having different strike prices and/or expiration months on the same underlying security.

To create a credit calendar spread, an investor should buy the near expiration. buy the distant expiration. sell the near expiration. sell the distant expiration. A) II and III. B) II and IV. C) I and IV. D) I and III.

Answer: C A credit calendar spread occurs when premium received exceeds the amount paid out. An investor creates a credit spread by selling the distant expiration and buying the near expiration. The distant expiration has more time value, and therefore, a higher premium.

Due to an escalating trade war, the portfolio manager of an equity mutual fund anticipates a negative impact on his fund's assets. To protect his investment portfolio, the fund manager would: A) sell S&P 500 index calls. B) sell S&P 500 index puts. C) buy S&P 500 index puts. D) buy S&P 500 index calls.

Answer: C A portfolio manager who expects a decline in the market as a result of a trade war (or any factor that might hurt stock prices) would buy puts on a broad market index such as the S&P 500 to protect his position. Selling calls limits upside potential, and only protects the portfolio to the extent of the income received from the sale of the calls.

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 puts on the stock. D) Buying 5 calls on the stock.

Answer: C 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.

An XYZ June 40 put trading at 4 would be considered in the money if XYZ is trading: A) above $40 only. B) above $44 only. C) below $40 only. D) below $36 only.

Answer: C A put is in-the-money, or has intrinsic value, whenever the price of the stock is below the strike price. The put would be in-the-money below $40.

A call option premium increases in price by .85. What is the dollar amount of that increase? A) 8.5. B) 850. C) 85. D) 0.85.

Answer: C A single point on an option is $100; therefore, .85 is $85.

Which of the following statements regarding index options are TRUE? Exercise is settled in cash. Exercise settlement value is based on the value of the index at the time exercise instructions are received. Exercise settlement value is based on the closing index value on the day exercise instructions are tendered. Exercise settlement is regular way. A) II and III. B) II and IV. C) I and III. D) I and II.

Answer: C All index option exercises are settled in cash. The amount a writer owes the holder is known as the intrinsic value of the option, and the settlement value is based on the closing index value on the day exercise instructions are tendered. Settlement is next business day.

Which of the following positions exposes a customer to unlimited risk? A) Short 2 XYZ calls. B) Short 200 shares of XYZ and short 2 XYZ puts. C) All of these. D) Short 200 shares of XYZ.

Answer: C All of the positions expose the client to unlimited risk.

American style options traded on the CBOE are priced higher than European style options on the same underlying stock, having the same expiration because: A) European style option positions cannot be traded out of. B) US investors cannot use European style options thus the demand is much less leading to lower premiums. C) American style options can be exercised at any time until expiration, while European style options can be exercised only at expiration. D) European style options are not adjusted for stock splits and stock dividends.

Answer: C American style options can be exercised at any time until expiration, while European options can be exercised only at expiration. With all other specifications the same, the American style option will have the higher premium because it allows the holder broader exercise rights.

An investor establishes the following positions: Long 200 XYZ shares Short 5 XYZ Jul 50 calls at 5 This strategy is known as a: A) reverse spread. B) diagonal spread. C) ratio write. D) combination.

Answer: C An investor establishes a ratio write by writing calls that represent more shares than he owns. The uncovered short calls represent unlimited maximum loss potential.

Which of the following positions has an unlimited dollar risk? A) Short 1 ABC Jan 35 call; long 1 ABC Jan 40 call. B) Short 100 shares of ABC; long 1 ABC call. C) Short 1 ABC Jan 50 put; short 100 shares of ABC. D) Short 1 ABC Jan 50 put.

Answer: C An investor faces unlimited dollar risk when short stock, short a naked call, or when a short stock position is combined with a short put. In this position, the unlimited risk of the stock is only protected on the upside by the premium received.

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 option's time value equals its intrinsic value. C) The time value is zero. D) The option is at-the-money.

Answer: C 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.

On November 4, a customer writes an S&P 100 Jan 785 put at 6. Maximum gain is achieved on his position if, on the expiration date, the S&P 100 closes at which of the following prices? A) 781 B) 783 C) 786 D) 779

Answer: C At the strike price of 785 or above, the put expires worthless and the customer keeps the premium received for writing the option.

If a customer establishes a debit spread, the customer profits if the: spread widens. spread narrows. option expires. options are exercised. A) II and III. B) II and IV. C) I and IV. D) I and III.

Answer: C Because debit spreads are closed as credits, the customer profits if the spread widens. In addition, to realize maximum profit, both contracts must be exercised. If they expire, the customer loses the net debit paid for a maximum loss.

If a customer is long 1 GGZ Oct 50 call at 11 and short 2 GGZ Oct 60 calls at 5, the maximum loss potential is: A) 1000. B) 1100. C) unlimited. D) 100.

Answer: C Because the customer is short 2 calls and long 1 call, one of the short calls is uncovered. The loss potential for a naked call writer is unlimited on the upside.

A customer buys 300 LMN at 45 and writes 3 LMN Aug 45 calls at 4. The customer will profit under all of the following circumstances EXCEPT if LMN: A) rises and the calls are exercised. B) is between 41 and 45 at expiration. C) is below 41 at expiration. D) remains at 45 through expiration.

Answer: C Breakeven is 41 (45 − 4). If the stock is below 41 at expiration, the customer will incur a loss.

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 III. D) I and II.

Answer: C 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 customer believes ABC's stock price will rise, but does not currently have the money to buy 100 shares. How could the customer use options to profit from a rise in the stock's price? Buy calls. Write calls. Buy puts. Write puts. A) II and III. B) II and IV. C) I and IV. D) I and III.

Answer: C Buying calls and writing puts are bullish strategies.

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) III and IV. C) I and III. D) I and IV.

Answer: C 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.

If an investor is long 5 Dec puts on the Canadian dollar, these options will expire in December on: A) the Wednesday after the third Saturday. B) the Friday preceding the third Wednesday. C) the Saturday after the third Friday. D) the third Friday of the month.

Answer: C Currency options, like equity options, expire on the Saturday following the third Friday of the expiry month.

US exchange listed foreign currency option premiums are quoted in which of the following? A) Percentage of value of the foreign currency B) Both units of foreign currency and the percentage of value of the foreign currency C) US dollars D) Units of foreign currency

Answer: C Foreign currency option premiums are quoted in US dollars. Because one point equals $100, a premium quote of 1.70 equals $170.

Japan discovers oil in the Pacific, while earthquakes in England cause havoc. A customer who reads the above article would be most likely to take which of the following actions? Buy yen calls. Buy yen puts. Buy pound calls. Buy pound puts. A) II and III. B) II and IV. C) I and IV. D) I and III.

Answer: C Here, the yen will go up and the pound will fall. Thus, a customer would be most likely to buy yen calls and pound puts.

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) II and IV. C) I and IV. D) I and III.

Answer: C Holders of yield-based call options profit if rates rise. Prices of debt securities fall if rates rise.

An investor is short stock at 70. If the stock's market price is 40 and the investor anticipates the price will continue to decline, to hedge against a rise in the price the investor should: A) buy a put. B) buy a straddle. C) buy a call. D) sell a call.

Answer: C If the investor buys a call on the stock, he has the right to buy it back (cover his short) at a fixed price. The best way to hedge an unrealized gain on a short stock position is to buy a call.

After selling ABC short at 70, a customer holds the position as ABC gradually falls to $53 per share. Which of the following strategies would best protect his gain? A) Write 55 puts. B) Buy 55 puts. C) Buy 55 calls. D) Write 55 calls.

Answer: C If the investor buys the 55 calls, he has the right to purchase the stock at $55 per share. If exercised, the investor has a 15-point gain, less the premium paid.

Which investor has the greatest potential risk if the price of QRS goes up? A) Long 10 puts on QRS. B) Short 10 puts on QRS. C) Short 10 calls on QRS. D) Long 10 calls on QRS.

Answer: C If the market is rising, the greatest potential risk that an investor can take is a short naked call because the potential loss is unlimited.

An options trader goes long 1 XYZ Oct 60 put at 6 and purchases 1 XYZ Oct 60 call for 6. If XYZ is at 68 at expiration, what is the investor's gain or loss? A) $400 gain. B) $1,200 loss. C) $400 loss. D) $200 gain.

Answer: C If the market price of XYZ is at $68 per share, the put is out-of-the-money and will expire worthless. The call could be sold for the intrinsic value of 8. (There is no time value, since the option is at the expiration date.) Since the investor originally spent $1,200 (a premium of $600 was paid for each option), the net result is a loss of $400.

Your customer is long 100 shares of ABC stock at $40 per share. To limit his downside risk with no additional money out of pocket, he buys 1 July 35 put at 2 and he sells 1 July 45 call at 2. This strategy limits his downside risk to what amount? A) 700. B) 800. C) 500. D) 600.

Answer: C If the stock price falls, the put purchase allows the customer to put or sell the stock to someone else at $35. This limits the downside risk to the difference between where the stock was purchased ($40) and where the customer can now sell it ($35) for a maximum loss of $5 per share, or $500. This strategy is known as a cashless collar because the premium paid for the put is exactly offset by the premium received for the call. Note that because of the short 45 call, upside potential is also limited to $500 in this example.

All of the following positions have limited loss potential EXCEPT: A) long stock/long put. B) short stock/long call. C) short stock/short put. D) long stock/short call.

Answer: C If the stock rises the put will expire leaving the customer short stock with an unlimited loss potential.

An investor owns 100 shares of IBM. Which of the following would make a long hedge? A) Writing a call. B) Writing a put. C) Buying a put on IBM. D) Buying a call on IBM.

Answer: C If you own the stock, you want the market value to rise. To hedge the position against a decrease in value, you would buy a put option.

A customer is long 1 XYZ Jan 50 put. In order to create a bull put spread, the customer must sell a Jan: A) 50 put. B) 45 put. C) 55 put. D) 50 call.

Answer: C In any spread, put or call, if the customer is buying the lower strike price, the spread is bullish. Therefore, to create a bull put spread, the customer (who is long the 50 put) must sell a put with a higher strike price. A bull put spread is also termed a short put spread.

Which of the following describes the position in a call option on a Swiss franc with a strike price of 120, a premium of 7, and a current market of 126? A) At the money. B) At parity. C) In-the-money. D) Out-of-the-money.

Answer: C In this case, the strike price is less than the market price so a call option would be in-the-money by the difference between the strike price and the market price (6 points, in this case). At-the-money means the strike price and the market price are the same; at parity means the premium equals the intrinsic value.

If an investor is bearish on the overall market, with no particular opinion on any individual stock, he will most likely: buy index calls. buy index puts write index calls. write index puts. A) I and IV. B) II and IV. C) II and III. D) I and III.

Answer: C Index options are useful for investors who have few opinions about individual stocks and who look at the market overall. If they are bearish, they choose short calls or long puts. Investors who are bullish on the overall market buy calls or sell puts.

If 1 OEX 375 call is purchased at 3.25 and exercised when the S&P 100 closes at 381, the writer delivers which of the following to the holder? A) $381 in securities. B) $600 in stocks. C) $600 cash. D) $325 cash.

Answer: C Index options settle in cash. Physical delivery does not occur. The call buyer receives cash equal to the difference between the strike price and the index closing value on the day the option is exercised.

All of the following subject an investor to unlimited risk EXCEPT: A) 1 ABC uncovered (short) call. B) short 100 ABC; write 1 ABC put. C) short 100 ABC; buy 1 ABC call. D) short 100 shares ABC stock.

Answer: C Investors use long calls to protect short stock positions. If the market value of the stock needed to cover the short position begins to rise, the investor can exercise the long call position to buy the stock. Short stock positions, short uncovered calls, and short stock combined with short puts, all subject investors to unlimited risk.

A customer buys 100 ABC at 62.75 and simultaneously buys an ABC Jan 60 put at 1. If the stock rises to 66.25, then the put expires and the customer sells the stock at the current price for a: A) gain of $350. B) loss of $250. C) gain of $250. D) loss of $100.

Answer: C Looking at each trade separately, the customer buys 100 ABC at 62.75 and sells the shares at 66.25 for a $350 gain. The customer pays $100 for the put which expires worthless, resulting in a $100 loss. Overall, the gain is $250.

A customer establishes the following positions: Buy 100 ABC for 63 Write 1 ABC Jan 70 call for 1 What is the customer's maximum gain? A) 700. B) Unlimited. C) 800. D) 600.

Answer: C Maximum gain on the covered call position occurs when the stock's market value rises. The short call is exercised when the stock is above 70, so the stock bought for 63 will be sold for 70-a profit of $7 per share. In addition, the customer receives the premium of $1, so the total profit is $800 ($700 + $100).

The investor with the greatest potential risk if the price of XYZ goes up is the one who is: A) long puts. B) short puts. C) short calls. D) long calls.

Answer: C Only bearish investors are at risk if the stock price goes up. The bearish options are short calls and long puts. Short calls are the riskiest position. Put buyers stand to lose the premium paid, but call writers have an unlimited risk. They can be required to deliver stock at the exercise price, and to do so, they will have to purchase stock at the market price, no matter how high.

XYZ closed at 41 and the XYZ Mar 45 puts closed at 5.25. The puts are: A) out-of-the-money. B) at parity. C) in-the-money. D) at the money.

Answer: C Put options are in-the-money when the market price is below the strike price. In this case, the puts are in-the-money by 4.

Ratio call writing exposes an options investor to limited loss unlimited loss limited gain unlimited gain A) I and IV B) II and IV C) II and III D) I and III

Answer: C Ratio call writers assume unlimited loss potential in a rising market, and limited gain potential in a falling market. Maximum gain-while limited-occurs if the stock is trading at the strike price of the short calls at expiration.

All of the following option strategies could be effectively used in a bear market EXCEPT a: A) debit put spread. B) credit call spread. C) short straddle. D) short call.

Answer: C Short straddles are appropriate only in flat or neutral markets. The writer will lose in a rising market (the call will be exercised) or a falling market (the put will be exercised). Short calls and short call spreads are bearish, as are debit (long) put spreads.

A customer buys 1 XYZ Aug 50 put at 1 and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58. If XYZ is at 52 at expiration, the customer has a: A) loss of $600. B) gain of $400. C) loss of $400. D) gain of $600.

Answer: C The 50 put expires because it is out of the money. The customer closes the position in the 65 put by purchasing it for its intrinsic value, $1,300. Because the account was credited $900 when the spread was established, there is a $400 loss ($1,300 − $900). Alternately, breakeven is 56 (65 − 9) and the spread is bullish. Therefore, the customer makes money above 56 and loses below 56. Because the stock is at 52 at expiration, the customer has a $400 loss (56 to 52).

Which of the following are characteristics of the volatility market index (VIX)? It is a bullish or bearish measure. It is a measure of implied expectations of market volatility. It is often referred to as the CBOE index It is often referred to as the "fear" index. A) I and III. B) II and III. C) II and IV. D) I and IV.

Answer: C The VIX (volatility market index) is a measure of investors' expectations regarding market volatility. High or low readings are neither bullish nor bearish but instead reflect expectations of volatility in the S&P 500 over the next 30 days. This index is referred to as the "fear" index and VIX options are traded on the CBOE.

As the price of the VIX (volatility market index) rises investors should expect: A) a decrease in call premiums only. B) a decrease in put premiums only. C) call and put option premiums to rise. D) call and put option premiums to fall.

Answer: C The VIX is a measure of investor expectations regarding market volatility. If the VIX is rising, this reflects an expectation of an increase in market volatility. More market volatility will generally cause all options premiums, both puts and calls to increase to some extent.

A customer is short 100 shares of DFI at 35 and the market price is 35.25. If he believes a near-term rally will occur, which of the following strategies would best hedge his position? A) Write a DFI put with an exercise price of 40. B) Write a DFI call with an exercise price of 40. C) Buy a DFI call with an exercise price of 35. D) Buy a DFI call with an exercise price of 40.

Answer: C The best hedge for a short stock position is to buy a call, not sell a put. If the stock price rises, the investor has the right to exercise the call and use the stock to close out the short position. To obtain the most protection, the call's strike price should equal the short sale price.

Your client sells 1 naked MAV Oct 40 call at 2 when the market price of MAV is $41. What must MAV be selling at for the client to break even? A) 40. B) 43. C) 42. D) 38.

Answer: C The breakeven point for a call is the strike price plus the premium. The breakeven point is the same for both the buyer and writer.

A client bought 100 XYZ at $65 per share and sold an XYZ 65 call at 8. Closing the short call at 10 and selling XYZ at 68 would result in a: A) $500 loss. B) $500 profit. C) $100 profit. D) $100 loss.

Answer: C The client made $300 on the stock and lost $200 on the option for a $100 profit.

A customer buys 100 DEF at 70, but several months later, the stock is trading at 82.85. The customer, concerned about a possible pullback, buys 1 DEF Aug 80 put at 1.50. If the stock subsequently falls to 77.25 and the customer sells his stock by exercising the put, the result is: A) gain of $575. B) gain of $875. C) gain of $850. D) loss of $150.

Answer: C The customer bought 100 shares at 70 and sold them at 80 by exercising the put for a gain of $1,000. However, it cost $150 to buy the put so the customer's gain is $850. In other words, breakeven for long stock-long put is the cost of stock purchased (70) plus the premium paid (1.50). Breakeven is 71.50 and the customer sold stock at 80 (80 − 71.50 = 8.50-point gain).

A customer purchases 200 shares of XYZ at 17.50 and writes 2 XYZ Jan 20 calls at 1. At expiration, with the stock trading at 19, the options expire worthless. If the customer sells his long stock at the current market price, the gain is: A) 350 B) 700 C) 500 D) 250

Answer: C The customer buys stock at 17.50 and sells his shares at 19 for a gain of $300. In addition, the customer keeps the $200 in premiums for an overall gain of $500.

If a customer does not anticipate that a stock's price will change and he wants to take an option position, he would most likely: A) buy a put. B) buy a straddle. C) write a straddle. D) buy a call.

Answer: C The customer earns combined premiums when selling a straddle (sale of a call and put with same terms). He hopes the market price will not move, both positions will expire unexercised, and he will keep the premiums. This position has unlimited loss potential should the underlying stock rise (because of the short call).

A customer buys 200 XYZ at 32, 2 XYZ June 35 calls at 3 and 1 XYZ June 35 put at 6.50. Two months later, the customer purchases 1 XYZ June 35 put at 4. Before expiration, with XYZ trading at 37, he sells his stock, and closes his calls at 2.10 and his puts at .25 for a: A) gain of $450. B) loss of $450. C) loss of $180. D) gain of $180.

Answer: C The customer opens 4 positions with debits to his account: 200 shares at $32 per share = a debit of $6,400; 2 calls at $300 each = $600; 1 put at $650 = a debit of 650; and finally, an additional put at $400. The stock position is sold for $37 per share for a credit of $7,400. The calls are closed for 2.10 each, a credit of $420, and the puts are closed for a credit of $25 each.

A customer is short 10 ABC Dec 50 calls at 2.50 and short 10 ABC Dec 50 puts at 3.50. Prior to expiration, ABC declines to 40.50 and the customer is assigned on his put position while his short calls expire worthless. A month later, he liquidates his long position at 45 for a: A) gain of $7,500. B) loss of $7,500. C) gain of $1,000. D) loss of $1,500.

Answer: C The customer opens two short positions on 10 contracts each, so his account is credited with premiums of $2,500 for the calls and $3,500 for the puts. The calls expire worthless, but the short puts are exercised, so the investor is required to buy the stock at the strike price. This results in a debit of $50,000 ($5,000 per contract × 10 contracts), and the stock is then sold at a credit of $45,000.

A customer shorts 100 XYZ at 51 and buys 1 XYZ Aug 50 call at 4. The stock falls to 45, at which time the customer closes the options contract at 1 and covers his short position at the current market price for a: A) $400 loss. B) $400 gain. C) $300 gain. D) $300 loss.

Answer: C The customer shorted stock at 51 and covered at 45 for a $600 gain, and then he bought a call at 4 and sold it at 1 for a $300 loss. Overall, the gain is $300.

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: A) 320. B) 350. C) 315. D) 190.

Answer: C 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 wishes to buy 1 XYZ Jan 40 call and write 1 XYZ Jan 45 call. At the time the order is placed, the options are trading as follows: Jan. 40 calls - 4.30 bid, 4.35 ask Jan. 45 calls - 2.25 bid, 2.30 ask If the transaction is effected at the market, the spread will be established at a: A) 1.75 debit. B) 1.85 debit. C) 2.10 debit. D) 1.50 debit.

Answer: C The investor establishes a debit spread by purchasing the 40 call at the ask price of 4.35 and selling the 45 call at the bid price of 2.25; the difference is 2.10.

An investor with no other positions buys 1 DWQ May 75 call at 6.50. If the investor exercises the call when the stock is trading at 77 and immediately sells the stock in the market, what is the investor's profit or loss? A) $350 loss. B) $450 profit. C) $450 loss. D) $350 profit.

Answer: C The investor exercised the right to buy the stock for 75 and can sell the stock in the market for 77, for a gain of 2. The investor paid a premium of 6.50 minus the gain of 2, which gives the investor a loss of 4.50 (4.50 × 100 = $450).

A customer establishes the following positions: Long 1 ABC Jun 25 call at 2 Long 1 ABC Jun 25 put at 2 What is the customer's expectation of the stock price between now and expiration? A) Bullish. B) Bearish. C) Volatility. D) Neutral.

Answer: C The investor has purchased a long straddle (both a call and put with the same strike prices and expiration months). While straddle investors are uncertain about the market's direction, long straddles require substantial price movement (volatility) for profit because the two premiums paid must be recovered. In this example, the market must either move up by 4 (total premiums paid) or down by 4 to reach breakeven. For profit, the market must be above or below the breakeven points.

An investor with no other positions buys 1 CDE May 65 put at 3.50. If the investor buys the stock at 63.50 and exercises the put, what is the investor's profit or loss? A) $350 profit. B) $350 loss. C) $200 loss. D) $200 profit.

Answer: C The investor has the right to sell the stock for 65 when it is currently worth 63.50 for a gain of 1.50. The investor paid a premium of 3.50 minus the gain of 1.50 for a loss of 2 (2 × 100 = $200).

An investor establishes the following position: Long 1 XYZ Sep 40 call at 2 The maximum potential gain on the position is: A) $40 per share. B) $42 per share. C) unlimited. D) $38 per share.

Answer: C The maximum gain on a long call is unlimited because, theoretically, a rise in stock price is unlimited.

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

Answer: C The maximum gain to an option writer is the premium received.

An investor bought 1 Apr KLP 40 call for 6 and 1 KLP Apr 50 put for 8 when KLP was at 45. If the stock declines to 44 and both the call and the put are sold at intrinsic value, the result would be a: A) $100 profit. B) $400 profit. C) $400 loss. D) $100 loss.

Answer: C The opening purchase of the Apr 40 call was made at 6 and the closing sale of that call was made at 4; the difference of 2 represents a $200 loss. The opening purchase of the Apr 50 put was made at 8 and the closing sale of that put was made at 6; the difference of 2 represents a $200 loss. The total loss for the account was $400. The position is a long combination.

On November 4, a customer writes an S & P 100 Jan 785 put at 6. The maximum potential gain on this position is: A) 300. B) unlimited. C) 600. D) 100.

Answer: C The potential gain on a short option is the premium received on the transaction

A customer who writes (sells) a naked call will profit if: A) the price of the option contract rises. B) the price of the underlying stock rises above the strike price plus the premium received. C) the option contract expires without being exercised by the owner. D) the customer is assigned on the contract.

Answer: C The writer of a call will profit if the contract expires unexercised. In which case, the premium received when the contract was written will be the profit. If the call writer is assigned, which means that it was exercised by the owner, it would be because the stock price has risen to greater than the strike price plus the premium; good for the call owner, but not the call writer. Remember that as the underlying security rises in price, so will the price of the call contract; once again, good for the call owner but not the call writer.

Using listed options to reduce the market risk in a stock position by taking an opposing position in the options that represent an equivalent number of shares is known as A) market timing. B) spreading. C) hedging. D) straddling.

Answer: C This describes hedging, a technique used to reduce the market risk or adverse price movement in a stock position using options. Each standardized listed equity option contract represents 100 shares so the number of contracts needed to hedge an existing stock position is determined by the number of shares the investor is currently long or short.

John Chance purchased a DMF May 90 call and simultaneously sold a DMF Jun 80 call. Which of the following best describes John's position? A) A long spread. B) A short spread. C) A bear spread. D) A bull spread.

Answer: C This investor has established a net credit diagonal call spread. He bought the lower premium call (higher strike and earliest expiry) and sold the higher premium call (lower strike and longest expiry). He hopes the spread will narrow to zero (if the market falls below 80 and both calls expire worthless) so he can keep all of the premiums. He is a bear and so is the spread.

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

Answer: C This is a call debit spread, and bulls buy calls. The 50 call is worth more because it has a lower strike price. Long the lower call is bullish; short the lower call is bearish.

In early September, a customer buys 100 shares of MCS stock for $83 per share and simultaneously writes 1 MCS Mar 90 call for $4 per share. The customer will break even when MCS stock is at: A) 87 B) 94 C) 79 D) 86

Answer: C This is a covered call writer. If the stock rises above $90, the writer will be exercised and will make $700 on the stock (buy at $83, deliver at $90) and keep the $400 received in premiums. If the stock declines, the call expires unexercised. The writer can lose $400 on the stock (the premiums earned) and still break even. This occurs at $79 ($83 − $4). Breakeven is cost of stock purchased less premiums.

If a customer buys 1 XYZ Jan 40 call and 1 XYZ Jan 40 put, paying total premiums of $650, and XYZ becomes worthless, the result is a: A) gain of $650. B) loss of $3,350. C) gain of $3,350. D) loss of $650.

Answer: C This is a long straddle in which breakeven points are established by adding and subtracting the combined premiums (6-½ points) from strike (the breakeven points are 46-½ and 33-½). The customer makes money if the stock moves above 46-½ or below 33-½. As the stock becomes worthless, the customer earns a 33-½ point gain on 100 shares, or $3,350.

The purchase of 200 shares of HGF at 45 and the subsequent sale of 2 HGF 50 calls at 3 could produce all of the following EXCEPT: A) a loss of $6,000. B) a profit of $1,600. C) a profit of $2,000. D) a loss of $8,400.

Answer: C This is covered call writing. The maximum loss that could be incurred is $8,400 ($9,000 paid for shares less premiums of $600 received). If you can lose $8,400 then you can certainly lose $6,000 (if, for example the value of the stock drops to 12). The maximum profit that can be expected is $1,600 (strike price of $10,000 received when calls are exercised less the purchase price of $9,000, plus $600 in premiums received). Since the maximum profit possible is $1,600, it is impossible to have a profit of $2,000.

A customer buys 1 LMB Aug 70 put for 4 and 1 LMB Aug 70 call for 4. If the price of LMB stock is $70, at what prices would the customer break even? $62. $66. $74. $78. A) II or III. B) II or IV. C) I or IV. D) I or III.

Answer: C To break even, the customer must recover $800 paid in premiums. On the long 70 call, this occurs if the market price rises to 78. On the long 70 put, this occurs if the market price falls to 62.

An investor buys 1 XYZ Nov 50 call at 8 and sells 1 XYZ Nov 60 call at 3.50. At what stock price will the investor break even? A) 60. B) 63.5. C) 54.5. D) 50.

Answer: C To determine the breakeven point, net the option premiums (8 − 3.50 = 4.50). For a call spread, add the netted premiums to the lower strike price (50 + 4.50 = 54.50).

Your client with a short call position in the S&P 100 index (OEX) is assigned an exercise notice. The obligation is fulfilled by delivering: A) 100 shares of a particular stock in the index selected by the option holder. B) a long call in the OEX at the same or lower strike price. C) cash equal to the difference between the closing value of the index and exercise price. D) 100 shares of each of the 100 stocks in the index.

Answer: C Unlike equity options, index options are settled in cash only. Upon exercise, cash equal to the amount that the option is in-the-money (i.e., excess of market value over strike for a call or excess of strike over market value for a put) is delivered on the settlement date.

Index options contracts that are commonly referred to as the "fear" gauge and based on the expected or implied volatility of the S&P 500 index are known as: A) the SPX or S&P 500 index options. B) the banking sector index options. C) the VIX or volatility market index options. D) the OEX or S&P 100 index options.

Answer: C VIX (volatility market index) options contracts are based on expected or implied volatility of the S&P 500. The VIX is commonly referred to as the "fear" gauge or index. When the VIX is high, it is neither a bullish nor bearish indicator but rather an indication of expected volatility in the market.

One cost efficient solution, or strategy, regarding the trading of options around certain news releases or events would be to use A) long-term equity anticipation (LEAP) contracts B) standard contracts bought on the first day they are issued C) weekly option contracts D) broad-based index contracts

Answer: C Weekly contracts offer a cost-efficient way to trade options around certain news releases like economic data or earnings reports by virtue of the low premiums they carry. Remember that part of an option contracts premium is a function of the time remaining until expiration. Because "weeklies" only have 1 week between the time they are issued and the time they expire, premiums tend to be low.

An index option differs from an equity option in that A) trading ends earlier in the day. B) they use European-style exercise. C) the exercise settlement is in cash. D) premiums tend to be somewhat higher.

Answer: C When an index option is exercised, settlement takes place in cash on the next business day.

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) $200 loss. B) $400 loss. C) $400 gain. D) $200 gain.

Answer: C 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.

A customer holds the following positions: Short 100 XYZ shares at 40 Short 1 XYZ Oct 40 put at 5 With XYZ trading at 35, the customer is assigned an exercise notice on the put and he uses the stock purchased to cover the short stock position, the customer has a A) $1,000 loss. B) $1,000 gain. C) $500 gain. D) $500 loss.

Answer: C When exercised, the customer is forced to buy stock at 40 that is used to cover the short position for no gain or loss. Because the premium of $500 was received, the investor has a gain of $500 on this position.

If a customer went long 10 Swiss franc puts (10,000 SF per contract) for a premium of 5.25 each, how much can the client lose on the total position of 10 contracts? A) 781.25. B) 1250. C) 5250. D) 525.

Answer: C When long an option contract, the maximum loss is the amount paid. Because the premium is in cents, multiply the figures to determine the total dollar amount ($.0525 × 10,000 × 10 contracts = $5,250).

Which of the following are call-buying strategies? Protection of a profit on a short sale of stock An increase in leverage with limited risk Acquisition of a position Diversification of a portfolio. A) II only. B) II and III. C) II, III and IV. D) I, II, III and IV.

Answer: D Call buying gives you the right to buy stock at a later date at the specified strike price. All selections listed are strategies that could warrant call buying.

An investor with no other positions sells 1 KLP Jul 40 call at 3.50. If the call is exercised when the stock is trading at 47, what is the investor's profit or loss? A) $450 profit. B) $450 loss. C) $350 loss. D) $350 profit.

Answer: C When the call was exercised, the investor was forced to buy the stock in the market for 47 and sell it to the call holder for 40. The loss of 7, minus the 3.50 premium received, gives the investor a loss of 3.50 (3.50 × 100 = $350). Writers of uncovered calls, if exercised, must sell (deliver) stock at the strike price.

The market attitude of an investor with no other position who writes an at-the-money call is: A) bullish/neutral. B) bearish. C) bearish/neutral. D) bullish.

Answer: C Writers of calls are bearish. However, when an investor writes an at-the-money call, the investor profits even if the market price of the stock does not move (neutral) because the option will expire worthless. The customer profits to the same degree if the stock falls out-of-the-money.

The market attitude of an investor with no other position who writes an at-the-money put is: A) bearish. B) bearish/neutral. C) bullish/neutral. D) bullish.

Answer: C Writers of puts are bullish. However, an investor who writes an at-the-money put profits even if the market price of the stock does not move (neutral) because the option will expire worthless. The customer also profits if the stock rises out-of-the-money.

A customer writes 1 ABC July 45 put at 3 when ABC is trading at 46. Maximum potential loss is: A) 4300. B) unlimited. C) 4200. D) 300.

Answer: C Writers of puts are bullish. If the stock falls below the strike price, the customer will be exercised and forced to buy stock at 45. If the stock becomes worthless, the customer will lose $4,500. However, the customer received $300 for writing the option. Maximum loss equals the breakeven point (SP minus premiums) multiplied by 100 shares.

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? Short straddle Short call Short put. A) II only. B) II and III. C) I, II and III. D) I only.

Answer: C Writers win 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.

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

Answer: C 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.

Which of the following is TRUE concerning yield-based (interest rate) debt options? A) American style exercise. B) Debt securities are delivered to the writer of the contract when the contract is exercised. C) European style exercise. D) Debt securities are delivered to the contract owner when exercised.

Answer: C Yield-based debt options are European style contracts meaning that they can only be exercised on the last trading day before expiry. All yield-based contracts when exercised are settled in cash. There is no delivery of debt instruments when these contracts are exercised.

Which of the following options strategies could be used by an investor who is bearish on a stock? Debit call spread. Debit put spread. Long call. Long combination straddle. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D A debit put spread is a bearish strategy that could realize a profit (the difference between the strike prices minus the premium paid for the spread) if the stock price fell. A long combination, which consists of both a long call and a long put, is both bullish and bearish and could also yield a profit if the stock price fell as the result of the long put. However, both a debit call spread and a long call are bullish strategies and would not be used if one is bearish on the stock.

A person who buys a put will lose most or all of his investment if, just before expiration, the price of the underlying stock is: the same as the exercise price. greater than the exercise price. less than the exercise price. A) I and III. B) II and III. C) III only. D) I and II.

Answer: D A long put is profitable if the price of the underlying stock falls; if the price rises or stays the same, the put will expire worthless.

On a single day, a customer purchases 15 TPL Sep 50 puts at 6 and 15 TPL Sep 50 calls at 1. If the price of TPL is $45 per share and the customer has no other security positions, what is this position called? A) Covered. B) Combination. C) Spread. D) Straddle.

Answer: D A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration.

Which of the following statements regarding straddles are TRUE? An investor who expects no change in a stock's price and wishes to generate income sells a straddle. An investor who expects no change in a stock's price buys a straddle. An investor who expects a substantial decline in a stock's price sells a straddle. An investor who expects substantial fluctuations in a stock's price and is unsure as to direction buys a straddle. A) I and II. B) II and III. C) II and IV. D) I and IV.

Answer: D A long straddle is the purchase of a put and a call on the same stock when both options have the same terms. The long call is profitable if the market rises, while the long put is profitable if the market falls. An investor purchases a straddle if sharp market movement is expected but the direction is uncertain. A short straddle is the sale of a put and a call on the same stock with both options having the same terms. If the market value remains stable, the options expire and the seller keeps the premium, thereby generating income.

What is the following position? Buy 1 QRS May 40 call. Sell 1 QRS May 50 call. A) Time spread. B) Diagonal spread. C) Combination. D) Price spread.

Answer: D A price spread is composed of a long and short option of the same type with the same expiration, but different strike prices. A price spread is also termed a vertical spread.

If the current OEX is valued at 487.95, which of the following option positions will be considered to be in the money? A) Dec 490 Call. B) Jan 485 Put. C) Jan 495 Call. D) Dec 490 Put.

Answer: D A put is in the money if the current market value is below the strike price. A call is in the money if the current market value is above the strike price.

Under which of the following circumstances would an investor risk an unlimited loss? Short 1 IBS Jul 50 put. Short 100 shares of IBS stock. Short 1 IBS Jul 50 uncovered call. Short 1 IBS Jul 50 covered call. A) I and II. B) I and III. C) II and IV. D) II and III.

Answer: D A short stock position gives an investor unlimited risk potential if the stock should rise because the investor must eventually buy back the stock at the higher price. Because stock can rise an unlimited amount, there is unlimited risk. The sale of a naked call requires that, if exercised, the writer must buy the stock in the market and deliver it at the strike price.

All of the following option positions have limited potential loss EXCEPT: A) long calls. B) long puts. C) short uncovered puts. D) short uncovered calls.

Answer: D A short uncovered call has unlimited potential loss because, theoretically, a stock's price can rise indefinitely. The potential loss on a short uncovered put can be large but is limited to the put's strike price minus the premium received per share. The potential loss on a long call or a long put is limited to the premium paid.

If a customer wishes to buy 1 XYZ option and sell another XYZ option, but he is not willing to spend more than $300, which of the following orders should be entered? A) 2 stop orders. B) 2 limit orders. C) A straddle order. D) A spread order.

Answer: D A spread involves the simultaneous purchase and sale of different option contracts of the same type. A spread incurs a gain or loss depending on what happens to the difference in the premiums between the two contracts. Because this investor wants to limit his risk to $300, he would buy the spread at a net debit of $300 or less (this is one order, not two).

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

Answer: D 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 is inversely related to the length of time an investor holds an option? A) Intrinsic value. B) Value of the underlying stock. C) Volatility. D) Time value.

Answer: D An option's time value diminishes as the option nears expiration. The longer an option is held, the less time remains.

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 calls. B) Buy yen puts. C) Sell yen puts. D) Buy yen calls.

Answer: D 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.

In April, a customer sold short 100 shares of QRS stock at $50 and simultaneously wrote 1 QRS Jan 50 put for a premium of $7. If the January put is exercised when the market value of QRS is 43 and the stock acquired is used to cover the short stock position, what is the customer's profit or loss per share? A) 0. B) $7 loss. C) $14 loss. D) $7 gain.

Answer: D Because the stock is purchased on exercise of the short put for $50 and is used to cover the $50 short sale, the investor incurs no gain or loss on the stock. The customer keeps the $700 collected in premiums for a profit of $7 per share.

Breakeven on a long put is the: A) current price less the premium. B) strike price plus the premium. C) current price less the strike price. D) strike price less the premium.

Answer: D Breakeven for the buyer or seller of a put is the same: the option's strike price minus the premium.

An investor wants to profit from a speculative, near-future market advance, but he is uncertain which stocks will be affected. To limit his risk to a specific amount, which of the following actions would best meet his objectives? A) Sell puts on a narrow-based stock index. B) Buy calls on a narrow-based stock index. C) Purchase several blue-chip stocks on margin. D) Buy calls on a broad-based stock index.

Answer: D Broad-based index options allow investors to profit on their beliefs about movement in the overall market. Index calls profit the investor if the index closes above the strike price plus the premium paid. The investor has limited risk, because only the premium of the option can be lost if the market moves downward. Narrow-based index options involve a single market sector only (for example, technology stocks).

On December 13, an investor buys 6 ABC Feb 60 calls at 2.25 each, when ABC is trading at 59.50 per share. If the calls expire unexercised, how much money will the investor lose? A) 225. B) 810. C) 6000. D) 1350.

Answer: D Buyers of options lose premiums if the options expire unexercised. The most this investor can lose is the number of contracts (6) multiplied by the amount of the premium (2.25). This investor's maximum loss is $1,350.

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

Answer: D 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.

An investor who owns XYZ stock is optimistic about the long-term growth potential of the company. However, the stock, currently priced at $58, has made a sharp advance in the last week and the investor wants to lock in a minimum price in case the share price drops. Which of the following option transactions will help meet the investor's objective? A) Sell $55 put options. B) Sell $55 call options. C) Buy $55 call options. D) Buy $55 put options.

Answer: D Buying the puts creates a long stock, long put hedge position. The exercise price for a put is the price at which the owner of the put can sell the stock when the put is exercised. With this position, if the stock falls, the investor will exercise the put and sell the stock at $55. Thus, a sale price of $55 will be assured in the event that the stock price falls.

Which of the following are spreads? Long 1 FLB May 40 call; short 1 FLB May 50 call. Long 1 FLB May 40 call; long 1 FLB May 50 call. Long 1 FLB Aug 40 call; short 1 FLB May 40 call. Long 1 FLB Aug 40 call; short 1 FLB Aug 50 put. A) I and II. B) II and III. C) II and IV. D) I and III.

Answer: D Choices I and III fit the definition of a call spread because each includes one long and one short option of the same type with different strike prices (I, a price spread) or different expiration dates (III, a time spread). Choice II involves options of the same type, but both are long. Choice IV involves options of different types.

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

Answer: D 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.

All of the following are suitable objectives for a covered call writer EXCEPT: A) providing downside protection for a long stock position. B) increasing return on a long stock position. C) speculating that a stock will not rise in price. D) profiting from an increase in the price of stock.

Answer: D Covered call writers sell stock at the strike price if exercised. This strategy provides downside protection to the extent of the premium received, increases the rate of return on a long stock position (because of the premium collected).

Covered call writing normally occurs in a A) rising market. B) falling market. C) volatile market. D) stable market.

Answer: D Covered call writing normally occurs in a stable market. In a rising market, writing calls against a long stock position limits upside potential. In a falling market, the calls only provide downside protection to the extent of the premium received.

If an investor establishes a call spread, and buys the lower exercise price and sells the higher exercise price at a net debit, he anticipates that the: A) spread will narrow. B) price of the underlying stock will not change. C) exercise prices will change. D) spread will widen.

Answer: D Debit spreads are profitable when both sides are exercised or the spread widens between the premiums. Credit spreads are profitable when both sides expire or the spread narrows between the premiums.

Which of the following would protect a short May 50 call? A) Long April 55 call. B) Long April 45 call. C) Long June 55 call. D) Long June 45 call.

Answer: D For a long call to cover a short call, it must have the same or lower strike price and the same or longer expiration. This ensures the investor may purchase the stock without financial loss and deliver it at 50 if the short call is exercised.

A customer writes 10 XYZ Jan 60 calls at 3.50 when XYZ is trading at 61. Which of the following statements regarding gain and loss are TRUE? Maximum gain is $56,500. Maximum gain is $3,500. Maximum loss is $63,500. Maximum loss is unlimited. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D For any writer, maximum gain is limited to the premium received (in this case it is $3,500). For uncovered call writers, maximum loss potential is unlimited.

IBM sold computers to a Soho retailer and agreed to accept payment of 10 million British pounds in 65 days. In which of the following ways could the company protect the payment against adverse foreign currency fluctuations? A) Buy pound calls and/or sell pound puts. B) Buy U.S. dollar puts and/or sell U.S. dollar calls. C) Buy U.S. dollar calls and/or sell U.S. dollar puts. D) Buy pound puts and/or sell pound calls.

Answer: D If the company wants to protect its investment, it has to protect against the payment going down in value relative to the cost. To protect against the value of the payment going down in relation to the cost, the company would buy puts on the payment currency. To offset the cost of the puts, the company will also sell calls. The calls will be covered by the ownership of the actual currency.

Which of the following has the least amount of risks? Long a call in a rising market. Long a put in a falling market. Short a call in a rising market. Short a put in a falling market. A) I and IV. B) II and III. C) III and IV. D) I and II.

Answer: D If the market goes up, the value of call options increases and the value of put options decreases. The opposite is true in a falling market. To be long an option is always less risky than being short, because in a long position, the most one can lose is the option premium. If the market acts unfavorably, simply let the option expire. Such is not the case when writing options; there is no control over when the stock will be put to or called away from the customer.

If a customer writes 1 uncovered in-the-money put, the maximum loss to the customer is: A) the strike price plus the premium multiplied by 100 shares. B) unlimited. C) 100% of the premium. D) the strike price minus the premium multiplied by 100 shares.

Answer: D If the stock becomes worthless, the investor will be forced to buy the stock at the strike price, but still keeps the premium received when the option was written. Essentially, maximum loss is breakeven multiplied by 100 shares.

If a customer believes that the market price of a stock will sharply rise or fall in the near future, which of the following strategies is best? A) Buy a call. B) Write a call. C) Write a straddle. D) Buy a straddle.

Answer: D If the stock goes either up or down sharply, the investor will profit from owning a straddle.

Which of the following strategies is intended to be profitable with either a significant upside or significant downside move in the underlying stock? A) Vertical spread. B) Horizontal spread. C) Short straddle. D) Long straddle.

Answer: D If the stock moves sharply up or down, the customer will profit from owning a long straddle

If assigned or closing the position, writers of puts might be required to sell the underlying stock. buy the underlying stock. sell the outstanding put. buy the outstanding put. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D 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.

In a bull call spread, an investor: buys the lower exercise price and sells the higher exercise price. buys the higher exercise price and sells the lower exercise price. anticipates the spread will narrow. anticipates the spread will widen. A) I and III. B) II and III. C) II and IV. D) I and IV.

Answer: D In a bull call spread (debit spread), a call with a lower strike price is purchased and a call with a higher strike price is sold. Because the long call has a lower strike price than the short call, it is more expensive, resulting in a net debit. In a bull call spread, the investor hopes the market prices rise. Maximum profit occurs if both calls are exercised, and because this is a debit spread, the spread is profitable if it widens.

The market attitude of a customer who establishes a credit call spread is: A) bullish. B) speculative. C) neutral. D) bearish.

Answer: D In a call spread, a customer is buying one call and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a short call spread, the short call position is dominant because it has the higher premium; writing calls is bearish.

Holders of long straddles would like the underlying stock to do all of the following EXCEPT: A) go up. B) go down. C) fluctuate. D) stay the same.

Answer: D In a long straddle, you are buying a put and a call. Holders can only profit if the stock moves farther away from the strike price than the total of the premiums paid.

The market attitude of a customer who establishes a debit put spread is: A) bullish. B) speculative. C) neutral. D) bearish.

Answer: D In a put spread, a customer is buying one put and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a long put spread, the long put position is dominant because it has the higher premium; buying puts is bearish.

When comparing a short call to a credit call spread, all of the following are true EXCEPT: A) maximum gain is limited in both positions. B) both positions are bearish. C) both positions generate premium income. D) maximum loss is limited in both positions.

Answer: D In any spread, both maximum gain and maximum loss are limited. In a short call, gain is limited to the premium received, but loss is unlimited. Short calls and credit call spreads are bearish, and both generate premium income. The investor who writes a call spread receives premium income (a short call spread is a credit spread).

Listed options on U.S. exchanges are available on all of the following currencies EXCEPT the: A) Euro. B) Japanese yen. C) Canadian dollar. D) U.S. dollar.

Answer: D In the U.S., exchange listed currency option contracts exist on foreign currencies, not on the U.S. dollar. With U.S. exchange listed currency option contracts, the U.S. dollar is the base currency to which movements in the foreign currency is compared.

What has a customer established who buys 5 XYZ Jan 40 calls at 6 and writes 10 XYZ Jan 50 calls at 1 when XYZ is trading at 43? A) Short combination. B) Ratio straddle. C) Long combination. D) Ratio spread.

Answer: D In theory this position is just like ratio call writing where more calls are written (sold) than stock is owned. When a ratio spread is established a customer writes (sells) more contracts than are being purchased. In this case, the customer is buying 5 calls and selling 10 calls. In a ratio call spread, potential loss is unlimited because the additional calls sold are uncovered (naked).

Index options are frequently used to protect a portfolio against which of the following risk types? A) Business. B) Credit. C) Inflation. D) Systematic.

Answer: D Index options protect investor portfolios from the risk of overall market movement, also known as systematic risk.

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

Answer: D Like a standard options contract, the size of a LEAPs contract is 100 shares.

Which of the following statements regarding the exercise of options contracts are TRUE? The exercise of equity options settles the next business day. The exercise of equity options settles in 3 business days. The exercise of index options settles next business day. The exercise of index options settles in 3 business days. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D Listed equity options, if exercised, settle in 3 business days. Index options, if exercised, settle on the next business day in cash.

With no other positions, a customer sells short 100 TIP at 40 and sells 1 TIP Oct 40 put at $5. At what stock price will the customer break even? A) 35. B) 40. C) 50. D) 45.

Answer: D On the downside, the short position fully covers the short put and the profit is the $500 premium. On the upside above 40, the short put expires and the short stock position loses money. The first 5 points of loss (40 to 45) on the short stock position are offset by the premiums received. Above 45, losses begin and are potentially unlimited.

Which of the following is a derivative security? A) DPPs. B) REITs. C) ADRs. D) options.

Answer: D Options are known as derivative securities because they derive their value from that of the underlying security.

Listed stock options expire on the: A) first business day following the day an option ceases to trade. B) same day an option ceases to trade. C) third Friday of the month that begins the next cycle. D) Saturday following the day an option ceases to trade.

Answer: D Options expire on the Saturday immediately following the third Friday of the expiration month, at 11:59 pm ET.

All of the following are advantages of buying a put versus selling stock short EXCEPT: A) buying a put has a lower dollar-loss potential than does selling stock short. B) buying a put would require a smaller capital commitment. C) one need not locate securities to be borrowed to buy a put. D) the put's time value, which gradually dissipates, is added to the intrinsic value.

Answer: D Selling short could result in unlimited loss, whereas buying a put limits loss to the premium and requires a smaller capital outlay than does selling short. Remember that short sales must be done in a margin account and 50% of the short market value (SMV) is required to be deposited by the short seller. Short sales require locating the securities to be borrowed; buying a put does not. The time value that erodes in a put option is a disadvantage because for each day that elapses, the option's time value decreases.

Which of the following positions subject an investor to unlimited risk? Short naked call. Short naked put. Long put. Short sale of stock. A) I and II. B) I and III. C) II and III. D) I and IV.

Answer: D Short stock and short naked calls subject an investor to unlimited risk because there is no limit on how high a stock's price might rise. Risk is limited for the other positions.

A customer sells an FLB Mar 35 call. To establish a straddle, she would: A) sell an FLB Mar 40 call. B) buy an FLB Mar 35 put. C) buy an FLB Mar 40 call. D) sell an FLB Mar 35 put.

Answer: D Straddles involve options of different types, but both options must be of the same series. An option series has the same strike price, expiration date, and underlying security.

Which of the following statements regarding investors who trade options that are American-style exercise is TRUE? A) They can only close out long positions during a brief time prior to expiration. B) They can only exercise their contracts on the last day of trading (the business day preceding expiration). C) They can only be purchased or sold on the very first day they are issued. D) They can exercise their options any time prior to expiration.

Answer: D The American-style exercise contract allows investors to exercise their options any time before expiration. With European exercise style contracts, exercise is only permitted on the last trading day.

An active options trader establishes the following position: Long 10 ALF Apr 40 calls at 6 Short 10 ALF Apr 50 calls at 2 What is the breakeven point? A) 4. B) 40. C) 46. D) 44.

Answer: D The breakeven on a call spread is determined by adding the difference in premiums (6 − 2 = 4) to the lower strike price. In this case, the net debit is 4 points. Therefore, 4 + 40 = 44.

An investor buys 6 DFI Feb 60 calls at 2.25 each. At the time of the purchase, DFI is trading at 59.50 per share. What price would DFI stock need to reach for the investor to break even? A) 57.75. B) 60. C) 61.75. D) 62.25.

Answer: D The breakeven point for a call, long or short, is strike price plus premium (60 + 2.25 = 62.25).

A customer establishes the following positions: Buy 100 ABC at 28 Buy 1 ABC Dec 25 put at 2 What is the breakeven point? A) 23. B) 27. C) 26. D) 30.

Answer: D The breakeven point is where an investor neither makes nor loses money. In this hedged position, the buyer must recover the cost of the stock and the premium paid to break even (28 + 2 = 30).

A customer shorts 1 OEX (S&P 100) 935 call at 7. If the customer is assigned an exercise notice on the call when the OEX closes at 944, the customer realizes: A) a $700 gain. B) a $900 loss. C) a $1,600 loss. D) a $200 loss.

Answer: D The call is in-the-money by 9 (944 − 935). The writer must deliver cash to the buyer equal to the intrinsic value. To determine the investor's profit or loss, the intrinsic value is reduced by the premium paid (9 − 7 = 2). Since each index point is worth $100, the investor has a loss of $200 because the money paid on exercise exceeded the premium received.

An investor buys 2 RST 40 calls and pays a premium of 4 each. He also buys 2 RST 40 puts and pays a premium of 2.50 each. When purchased, RST is trading at $40.75. On the expiration date, RST is trading at $32.50 and the investor closes his positions for intrinsic value. Excluding commission, the investor realizes a: A) $100 loss. B) $200 loss. C) $100 profit. D) $200 profit.

Answer: D The cost of opening these two straddles is $1,300. On the expiration date, the puts are worth $750 each, for a total of $1,500, giving the investor a $200 profit. The calls will expire worthless. Alternatively, the breakeven points for this long straddle are 33.50 and 46.50 (add the combined premiums of 6.50 to the call strike and subtract combined premiums from the put strike). The investor profits in a long straddle when the stock moves outside the breakeven points. As the stock is at 32.50, the customer makes 1 point (33.50 − 32.50) on each straddle, resulting in a $200 profit.

A customer buys 200 ABC at 76 and simultaneously writes 2 ABC MAR 80 calls at 2. If the stock rises to 83 and the customer is exercised, the customer has a gain of: A) 800. B) 1400. C) 1800. D) 1200.

Answer: D The customer bought 200 shares at 76 and was forced to sell those shares at 80 for a gain of $800. In addition, the customer received $400 for writing the calls, so the overall gain is $1,200. The price of 83 is irrelevant. It only explains why the customer was exercised (the 80 calls are in-the-money). Breakeven for covered call writing is the cost of stock (76) less premiums (2). The breakeven point is 74, and the customer sold at 80 (6 points × 200 shares = $1,200).

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? The gain is $250. The gain is $400. For tax purposes, cost basis per share is 62.50. For tax purposes, cost basis per share is 61. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D 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 a customer is long 1 ABC Oct 50 call at 11 and short 2 ABC Oct 60 calls at 5, the maximum loss potential is: A) 100 B) 1000 C) 1100 D) unlimited.

Answer: D The customer is short two calls and long one call, leaving one of the short calls uncovered. The loss potential for a naked call writer is unlimited on the upside. If exercised, the writer must buy the stock at the current market price so it will be delivered at the strike price.

A customer writes 1 XYZ Jul 70 call at 5 when XYZ is trading at 72. If the stock subsequently rises to 76 and the contract is exercised, the customer has: A) a gain of $100. B) a gain of $900. C) no gain or loss. D) a loss of $100.

Answer: D The customer was forced to sell stock at 70. To deliver the stock, the customer must buy it at the market for 76, for a $600 loss. However, the customer received a premium of $500 so the overall loss is $100. Alternatively, breakeven is 75 (strike price plus premium). Writers of calls, who are bearish, make money if the stock stays below the breakeven point. Above the breakeven point, writers of calls lose money. Because the contract was exercised when XYZ was 76 (1 point above the breakeven point), the customer has a $100 loss.

If an investor sells 1 AMF Apr 50 put for 2.50 and buys 1 AMF May 60 put for 7.75, the investor has profit when the spread narrows. the spread widens. both puts are exercised. both puts expire. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D The investor created a debit spread, which is profitable when both sides are exercised or the spread widens. Conversely, credit spreads are profitable when both sides expire or the spread narrows.

If an investor with no other positions buys 2 DWQ Jun 45 calls at 3, and he exercises the calls when the stock is trading at 47.25 and immediately sells the stock in the market, what is the investor's profit or loss? A) $75 profit. B) $75 loss. C) $150 profit. D) $150 loss.

Answer: D The investor exercised the right to buy the stock for 45, and can sell the stock in the market for 47.25 for a gain of 2.25. The gain of 2.25 minus the premium of 3 gives the investor a loss of .75 per share. Multiplying the .75 loss by 200 (the number of shares), results in a loss of $150.

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) $50 loss. B) $150 profit. C) $150 loss. D) $50 profit.

Answer: D 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).

An investor with no other positions sells 1 DEF Jan 95 put at 5.50. If the put is exercised when the stock is trading at 79 and the investor immediately sells the stock in the market, what is the investor's profit or loss? A) $550 profit. B) $550 loss. C) $1,050 profit. D) $1,050 loss.

Answer: D The investor has the obligation to buy the stock for 95 while the stock is currently worth 79, for a loss of 16. The loss of 16 minus the 5.50 premium received gives the customer a loss of 10.50 (10.50 × 100 = $1,050).

If a customer buys 500 shares of ABC at 48 and writes 5 ABC 50 calls at 2, what is the maximum loss? A) 1000. B) 4600. C) Unlimited. D) 23000.

Answer: D 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.

An investor writes 1 XYZ 280 put at 16.65. If the investor makes a closing purchase at the put's intrinsic value when the stock is at 265.25, he realizes a gain of: A) 147.5. B) 166.5. C) 265.25. D) 190.

Answer: D The investor's opening sale at 16.65 and closing purchase at 14.75 resulted in a difference of 1.90 for a total gain of $190.

If an investor buys 1 KLP Oct 95 put at 6.50, what is the investor's maximum potential gain? A) 9500. B) 9650. C) 10150. D) 8850.

Answer: D The maximum gain on a long put is calculated by subtracting the premium from the strike price (95 − 6.50 = 88.50 per share). One contract represents 100 shares, so the buyer's maximum gain is $8,850 if the stock declines to 0. Because put buyers are bearish, they will make money if the stock falls below the breakeven point of 88.50.

If a customer sells 3 DEF Feb 25 Puts at 4 when DEF is at 24, the maximum potential gain is: A) 400. B) 800. C) unlimited. D) 1200.

Answer: D The maximum gain when a put (or any option) is sold is the premium received. Since there are 3 contracts, the gain is 3 multiplied by $400, or $1,200.

What options trading program would be most appropriate for a retired customer with a portfolio of low cost basis blue-chip stocks who is seeking income from his portfolio? A) An option purchasing program. B) An uncovered call writing program. C) Selling straddles. D) A covered call writing program.

Answer: D The most conservative option strategy is writing covered calls. In addition to the income from the call premium, this client could receive dividends on his stock if any were paid as well. Purchasing options brings no income to the account and uncovered call writing and short straddles have unlimited risk.

If TCB is trading at 43 and the TCB Apr 40 call is trading at 4, what are the intrinsic value and the time value of the call premium? A) Intrinsic value 4; time value 0. B) Intrinsic value 3; time value 4. C) Intrinsic value 1; time value 3. D) Intrinsic value 3; time value 1.

Answer: D The option is in-the-money by 3 points because the strike price is 40 and the market price is 43. This sets a minimum premium of $3 per share. Because the actual premium is 4, the balance of 1 represents time value.

A technology fund manager concerned about a downturn in the value of his portfolio would hedge by: A) buying broad-based index puts. B) selling broad-based index calls. C) selling narrow-based index calls. D) buying narrow-based index puts.

Answer: D The portfolio consists of sector-specific securities, so broad-based index puts such as the OEX would not be appropriate. Instead, the manager should buy narrow-based index puts (for example, indices on technology and electronics).

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

Answer: D 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.

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

Answer: D The put is in-the-money when the underlying instrument's market price is below the put's strike price.

If a client bought 100 shares of GM at 88.50, and the same day he went long a put at 90 for 4.25 on GM due to expire within the month, what is the breakeven point? A) 84.25. B) 85.25. C) 90.25. D) 92.75.

Answer: D The stock is the dominant position. The breakeven point is calculated by adding the cost of the option to the cost of the stock. The stock must rise to 92.75 to break even.

If an XYZ Aug 80 put is trading at 2, at which price would the option be at parity with the stock? A) 82. B) 80. C) Any of the above. D) 78.

Answer: D The term "at parity" means the premium equals the intrinsic value that occurs for an in-the-money option prior to expiration when the time value has eroded. An 80 put is in-the-money by 2 points (the premium) when the underlying stock is trading at 78.

Which of the following would not be a concern for an investor writing a naked option? A) the risk/reward ratio. B) the loss potential. C) the possibility of exercise. D) the premium the investor must pay for the contract.

Answer: D The writer of any option contract receives the premium they do not pay it. A naked option writer would consider the risk/reward ratio, the loss potential, and the possibility that the contract would be exercised by the party who purchased it.

A registered representative executes the following trades for an options account: Buy 1 FLB Apr 40 call at 9 Sell 1 FLB Apr 45 call at 4 Are these suitable trades? A) It depends on the customer's investment objectives. B) It is impossible to tell. C) Yes, because the trades will result in a small profit. D) No, because the customer cannot make a profit on these trades.

Answer: D These trades are not suitable because the customer will not make a profit. In any price spread, the net debit represents maximum loss; in this case, the net debit is 5 points, or $500. Maximum loss added to maximum gain will always equal the difference between the strike prices. In this example, the difference between the strike price is 5 points, therefore maximum gain is 0.

A customer goes long an MMM Jan 40 put at 5 and writes an MMM Jan 50 put at 13. The customer will break even or profit when the market price is at all of the following EXCEPT: A) 42. B) 45. C) 48. D) 35.

Answer: D This is a bull spread; the investor wants the stock to rise. Breakeven for put spreads is computed by subtracting the net premium (8) from the higher strike price (50). If it stays above the breakeven price of 42, he will profit.

If a customer buys 100 XYZ at 49 and writes 1 XYZ Nov 50 call, receiving $350 in premiums, the breakeven point is: A) 46.5. B) 52.5. C) 53.5. D) 45.5.

Answer: D This is a covered call, so the investor is protected against declining stock prices to the extent of the premium received, and the breakeven is 45.50 (49 − 3.50).

Your client purchases 100 shares of XYZ common stock at $50 and sells two XYZ Oct 55 calls for a premium of $2 each. This investor's maximum potential loss is: A) 600. B) 4600. C) 4800. D) unlimited.

Answer: D This is a ratio write. The client is writing more calls than he has stock to cover. The first call is covered by the 100 shares of stock owned, but the second call is uncovered, or naked. A short naked call has unlimited loss exposure.

A customer writes 1 ABC Jan 65 put at 6 and 1 ABC Jan 55 call at 7 when ABC is trading at 60. This position will be profitable if, at expiration, ABC is above 68 at 60 below 52 between 52 and 68 A) I and II. B) I and III. C) II and III. D) II and IV.

Answer: D This is a short combination where both contracts are in-the-money. Short combinations are like short straddles, except the strike prices and/or the expirations are different. The breakeven points are computed by adding the combined premiums to the strike price of the call (strike price + premium) and subtracting the combined premiums from the strike price of the put (strike price − premium). The breakeven points, therefore, are 52 (65 − 13) and 68 (55 + 13). With a short combination, the investor makes money if the stock stays inside the breakeven points.

A customer is long 100 XYZ currently trading at $40 per share. To generate income, the customer writes 2 XYZ Aug 40 calls at 4 for a maximum loss potential of: A) 3200. B) 3600. C) 4000. D) unlimited.

Answer: D This is an example of ratio writing where a customer writes more calls than he has stock to cover. Because only one of the calls is covered, the other is uncovered and loss potential is unlimited.

If a customer buys 200 XYZ at 58 and writes 5 XYZ Jan 60 calls at 2, maximum potential loss is: A) 1400 B) 10600 C) 12600 D) unlimited.

Answer: D This is an example of ratio writing. Short calls are covered by long stock, but in this example it would take 500 shares of stock to cover the 5 calls written. Because there are actually 3 uncovered calls, the maximum loss is unlimited.

With XYZ trading at $47.50, your customer writes 1 XYZ January 50 put and simultaneously writes 1 XYZ January 45 call receiving $600 in combined premiums. Your customer's market attitude is: A) bullish. B) bearish. C) speculative. D) neutral.

Answer: D This position is a short combination where both contracts are in the money. Breakeven points are 51 and 44. Above or below these points, the customer will lose money.

If a customer buys 1 XYZ Nov 70 put and sells 1 XYZ Nov 60 put when XYZ is selling for 65, this position is a: A) bull spread. B) combination. C) straddle. D) bear spread.

Answer: D This put spread is established at a debit because the customer pays more for the 70 put than she receives for the 60 put. A debit spread is a net buy, while a credit spread is a net sale. Therefore, a debit put spread is like buying a put, which is bearish.

Which of the following determine the price of an options contract? The price of the underlying stock. The time remaining to expiration. The volatility of the underlying stock. A) I and II. B) I and III. C) II and III. D) I, II and III.

Answer: D Time remaining, volatility of the underlying stock, and price of the underlying stock all affect the price of an option on stock.

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

Answer: D To establish a short straddle, the investor sells a call and a put; the short call carries unlimited loss potential.

The S&P 100 index closed on August 10 at 536.04. "The Wall Street Journal" quotes the closing premium for the OEX September 510 call at 28.90. The time value of the contract is: A) 7.14. B) 18.9. C) 26.04. D) 2.86.

Answer: D To find time value, subtract the intrinsic value from the premium. The intrinsic value is the in-the-money amount. Calls are in the money if the market price exceeds the strike price. In this case, the intrinsic value of the 510 call is 26.04. If the premium is 28.90, the time value is 2.86.

Which of the following has unlimited risk if it is the only position in an account? A) Long put. B) Long call. C) Short put. D) Short call.

Answer: D Uncovered short calls carry unlimited risk.

Which of the following is TRUE regarding option contracts that expire weekly? A) They can only be traded for a single day. B) They expire on Mondays. C) They are issued every week of every month. D) They tend to have lower premiums than standard contracts or long-term equity anticipation (LEAP) contracts.

Answer: D 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 XYZ is trading at 39 and a customer sells 1 XYZ June 40 put and buys 1 XYZ June 35 put, he will profit if the: spread widens. spread narrows. contracts expire. contracts are exercised. A) I and II. B) I and IV. C) II and IV. D) II and III.

Answer: D When a spread's premiums are not available, the more valuable option is found by examining the strike price. A put with a higher strike price has a higher premium because a put represents the right to sell. Because the investor is selling the more valuable put (the one with the higher strike price), this is a credit spread, and profit occurs if the options expire worthless (in this case, the customer keeps the net credit) or the spread narrows between the premiums.

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: A) 0.4875. B) 0.4975. C) 0.5125. D) 0.8225.

Answer: D 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).

If an index option is exercised, the holder's account will be: A) debited the in-the-money amount. B) credited the out-of-the money amount. C) debited the out-of-the money amount. D) credited the in-the-money amount.

Answer: D When index options are exercised, settlement is in cash rather than stock. The option writer delivers cash to the option buyer equal to the amount that the option is in-the-money.

When stock prices are below strike prices, which of the following statements are CORRECT? Puts are in-the-money. Puts are out-of-the-money. Calls are in-the-money. Calls are out-of-the-money. A) I and III. B) II and III. C) II and IV. D) I and IV.

Answer: D When stock prices are below strike prices, puts are in-the-money and calls are out-of-the-money.

If a customer buys 100 shares of stock and writes one out-of-the-money call against his long position, the breakeven point is the: A) cost of stock purchased plus premium. B) strike price plus premium. C) strike price less premium. D) cost of stock purchased less premium.

Answer: D When the investor owns stock and sells a call, the call is covered. Breakeven is computed by subtracting the premium from the stock's purchase price.

An investor sells short 100 shares at 50 and sells a 50 put at 5. If the put is exercised when the stock is trading at 45, the investor realizes: A) neither a gain nor a loss. B) a gain of $1,000. C) a gain of $1,500. D) a gain of $500.

Answer: D When the short put is exercised, the investor buys stock at $50 that she can use to cover the $50 short sale. The investor realizes no gain or loss on the stock, but she collected $500 in premiums for a gain of $500.

If a customer writes 10 DEF Aug 50 calls at 1 when DEF is trading at 44, what is the maximum gain? A) 100. B) 500. C) Unlimited. D) 1000.

Answer: D 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.

As a registered representative you often have customers who are interested in learning about derivative products such as options and different derivative strategies. Of the following customer profiles which would writing calls be considered least suitable for? A) Miss Smith, age 41, able to add to her savings each month after living expenses from her monthly income. Currently building retirement account balances in an IRA and company sponsored 401k plan. Recently investing in an income producing vacation property her savings outside of retirement accounts currently total $70,000. Growth is listed on her investment account as her objective. B) Mr. Clark, a small business owner nearing the sale of his business to take an early retirement at age 52. A lump sum annuity has been in place in anticipation of the early retirement and the business sale proceeds will be more than adequate for his early anticipated living expenses. Current savings total $55,000 and his investment account objective is growth. C) Mr. and Mrs. Johnson, both young professionals with a combined annual income of $80,000. Both making small annual IRA contributions and participating in company sponsored 401k plans. Mrs Johnson will also be eligible for pension plan payments after retirement several years away. Current savings total $25,000 and their joint investment account objective is growth. D) Mr. and Mrs. Jones, both retired, covering monthly expenses with their social security and annual mandatory IRA withdrawals. Savings outside of retirement accounts total $25,000. Income is the investment objective listed on the account.

Answer: D While these profiles offer some guidance and any of them could be considered incomplete to some extent the one for whom writing calls would be considered the least suitable is the retired joint account; Mr. and Mrs. Jones. Factors to note would be the nominal total savings and that both are in retirement needing social security and mandatory IRA withdrawals to meet current living expenses. Consider that while writing calls brings income into an account it is a strategy that is high in risk with an unlimited maximum loss potential; not suitable for a retired couple in their position.

Which of the following transactions would be acceptable investments for a pension fund? Writing a call. Writing a covered call. Writing a put. Writing an S&P Index option. A) I and III. B) II and III. C) II and IV. D) II only.

Answer: D Writing a covered call has less risk than writing a naked option. A covered call writer is merely using options to increase the income on his portfolio. Fiduciaries should avoid risky transactions unless documentation specifies that this sort of investment is the objective of the fund.

Which of the following strategies is considered most risky in a strong bull market? A) Buying calls. B) Writing naked puts. C) Buying a put spread. D) Writing naked calls.

Answer: D Writing naked calls gives unlimited risk. If the market rises, naked puts expire. In the latter case, the writer profits from the premiums.

Your clients, an elderly retired couple on a small fixed monthly income, want to write uncovered (naked) calls in their joint account to generate income. For this account this option strategy would most likely be deemed: A) not suitable because this strategy cannot be used in a joint account B) suitable due to its minimal risk characteristics C) suitable as this would be considered a standard strategy recommended to all retired customers to add income to their accounts D) not suitable as this is a speculative strategy with unlimited loss potential

Answer: D Writing naked calls has an unlimited loss potential and is considered a speculative option strategy. While it can be employed in any investment account (single or joint) to generate income, its speculative nature and unlimited loss potential would make it unsuitable for retired persons currently on a small fixed monthly income.

Your client expects KLM Corporation stock to undergo a slight but long-term decrease in price. He is willing and able to take a risk to generate a small amount of income. Which of the following might be an effective strategy? A) Buy near-term, in-the-money KLM puts. B) Buy near-term, in-the-money KLM calls. C) Sell KLM LEAPS puts. D) Sell KLM LEAPS calls.

Answer: D Your customer wishes to generate income, which means he must sell something, not buy it. Since he is in a position to take a risk, and expects KLM's stock price to decline long term, selling LEAPS calls would be a possible strategy.