SIE Prep- Chapter 3 Questions
One of your clients that is a frequent options trader buys 100 shares of ABC common stock @ 45 and buys 1 ABC July 50 Put @ 4. Later the client decides to exercise the put and deliver the long stock position against the exercise. Upon completion of these transactions, for federal tax purposes the customer would have a
[A] $100 profit EXPLANATION Premiums Stock Trans. Buys 100 shares of ABC at 45 B - 4,500 Buys 1 ABC July 50 put @ 4 B - 400 exercises the put S + 5,000 - 400 + 500 \ / The customer's profit or loss + 100
An investor buys 100 shares of ABC at $50 per share and also sells 1 ABC April 45 call for 8. In the event that the investor is assigned an exercise notice and ABC is at 60, the trader's gain or loss on a per share basis would be:
[A] $3 profit EXPLANATION Premiums Stock Trans. buys 100 shares of ABC at $50 B - 5,000 sells 1 ABC April 45 call for 8 S + 800 assigned an exercise notice S + 4,500 + 800 - 500 \ / + 300 the trader's profit or loss per share 300 / 100 shares = $3 per share profit
A customer sells 1 WL September 100 call for 10 and buys 100 shares of WL stock at 105. If the customer is not assigned an exercise notice but instead executes a closing purchase at 10 and sells the stock at 108, he realizes a:
[A] $300 profit. EXPLANATION Premiums Stock Trans. sells 1 WL Sept 100 call for 10 S + 1,000 buys 100 shares of WL stock at 105 B - 10,500 closing purchase at 10 (of Sept 100 call) B - 1,000 sells the stock at 108 S + 10,800 0 + 300 \ / he realizes a + 300
A customer writes 10 ABC May 40 calls @ 4.75 when the market price of ABC is $42 per share. What is the customer's maximum gain potential?
[A] $4,750 EXPLANATION Premiums Stock Trans. writes 10 ABC May 40 calls @ 4.75 S + 4,750 Premium Income + 4,750 The customer's maximum gain potential in this question would be the premium income of $4,750.
A customer buys 100 WL shares for $55 each and sells one WL October 60 call for 3. What is the breakeven point on this position?
[A] 52 EXPLANATION Premiums Stock Trans. buys 100 shares of WL for 55 B - 5,500 sells 1 WL Oct 60 call for 3 S + 300 + 300 - 5,500 \ / -5,200 What is the breakeven point on the position? $5,200 / 100 shrs = $ 52
Which of the following option transactions are "opening sales"?
[A] An investor writes a call contract. EXPLANATION Remember "Buyer/Holder/Long" are all terms used for those buying option contracts. Remember "Seller/Writer/Short" are all terms used to describe those selling options. In this question, the only scenario that would be an "opening sale" would be the investor writing a call. A long straddle would be an opening purchase, the long stock/long put would also be considered a opening purchase as a hedge. The sale of a put to end an existing long put position would be considered a "closing sale", not an "opening sale".
Which of the following are true of the buyer of a call option? I. The profit potential is unlimited. II. The maximum loss is limited. III. The profit potential is limited. IV. The maximum loss is unlimited.
[A] I and II EXPLANATION I is correct because your profit potential is unlimited when you buy a call since you want the market price of the stock to go up. II is correct because when you buy a call the most you can lose is the premium paid for the option.
Regular-way settlement for options transactions is
[A] T+1. EXPLANATION Regular way settlement for transactions in options is T+1. If the customer does not pay in T+1, Reg T settlement provides the customer with a grace period settlement of T+4.
One of your clients performs the following transactions simultaneously: Short sells 200 shares of MNO stock at a market price of $25 per share Sells 2 MNO July 45 puts with a premium of 2 What is the maximum loss potential?
[A] There is unlimited loss potential. EXPLANATION The investor sold the puts (passenger) and has some upside protection with the premiums collected, but when a stock is sold short, there is no guarantee that the investor will be able to cover the short sale, so the investor's loss potential here is unlimited.
Each of the following are legitimate reasons for an investor to buy call options, EXCEPT:
[A] To sell stock at a premium above the current market price EXPLANATION Call options do not allow an investor to sell stock at a premium above the current market price. A long call option allows the investor to exercise and buy 100 shares of the underlying stock at a set price for a set period of time. So an investor may be able to buy at a price below the market price, but would not be able to sell stock above the current market price. Options can provide diversification, hedging, and leverage.
All of the following are reasons to write call options except:
[A] buy the underlying stock at a price which is below the current market price EXPLANATION The BUYER of a call would buy the underlying stock if the option were exercised. This question is about the WRITER of a call. Therefore the answer of "a" would not be applicable but "b", "c" and "d" are true.
All of the following positions have unlimited gain potential except
[A] long put EXPLANATION If we have a long put position, we would want the market value of the security to decrease. The market value cannot decrease below zero, so we would have limited profit potential. Buyers of Puts want the Market Value to go down because buyers of puts, have the right to sell stock. If the market value of the underlying stock goes down, then we can buy the stock for a lower price than exercise the option and sell the stock for the higher price. For example, if we are long a 50 put and the market value drops to 40 dollars. We can buy the stock at 40 dollars, and then exercise the option to sell stock at 50 dollars.
A client performs the following transactions: Buys 1 ABC Feb 45 Put @ 3 Buys 100 shares of ABC common stock at $45 per share What would the client's maximum profit potential be in this situation?
[A] unlimited EXPLANATION Since the client is Long 100 shares of ABC common stock the client has unlimited profit potential because there is no limit on how high the market value of the stock could go! Remember that this position is "hedged" since the investor is long the stock and bought a put.
A customer buys one ABC Sept 50 put for $2.50 when the price of ABC stock is 60. What is the MAXIMUM profit that the customer may realize?
[B] $4,750 EXPLANATION The customer can sell ABC at $50 and if the stock goes down to zero, he will have a profit of $5,000 ($50 x 100 shares). But, he had to pay $250 for the put ($2.50 x 100 shares = 1 contract). Therefore, his maximum net profit is $4,750
A client decides to buy 1 ABC March 50 call @ 4 when ABC is at 46. Later ABC declines to 40 and the call expires unexercised. The client would report which of the following on his tax return?
[B] $400 capital loss on the transaction EXPLANATION Options are classified as capital assets and therefore any gain or loss would be treated as a capital gain or a capital loss. The customer bought a call for $400 which expired therefore the customer would end up with a capital loss of the $400 premium he paid.
An investor buys 100 shares of ABC at $47 per share. Later, the investor writes an ABC Aug 50 call at 4. The investor will break even when the underlying stock is at:
[B] $43 EXPLANATION Premiums Stock Trans. buys 100 shares of ABC at $47 per share B - 4,700 writes 1 ABC Aug 50 call at 4 S + 400 + 400 -4,700 \ / the breakeven price would be - 4,300 / 100 shares = $43/share
An investor writes a May 50 put @ 6 in February and the put is exercised on May 7. Eight weeks later the investor sells the stock @ $52 a share. The investor's profit or loss is?
[B] An $800 capital gain EXPLANATION Premiums Stock Trans. writes a May 50 put @ 6 S + 600 the put is exercised B - 5,000 sells the stock at 52 S + 5,200 + 600 + 200 \ / + 800
A put has the highest value to the buyer when the underlying security is:
[B] Falling in market value EXPLANATION Put buyers expect the market value of the underlying security to decline.
A trader buys 1 ABC July 50 put for 6. To close this position, the trader must:
[B] Sell 1 ABC July 50 put EXPLANATION Selling the same put will liquidate the long put position.
The holder of a stock index option upon exercise receives:
[B] The in the money amount x $100. EXPLANATION Upon exercise an investor would receive the difference between the exercise price of the option and the current index (which would be the "in the money" amount) times the multiplier of $100.
An investor with a large portfolio of equity securities wants to write covered calls against his portfolio. All of the following are true about this type of strategy EXCEPT?
[B] This strategy will work best during a Bullish market EXPLANATION Covered Call writing is generally used when a neutral or down market is expected. If the investor felt bullish about the market they should not write covered calls because they would then limit their participation in the up move their long stock positions to whatever the strike price is on the calls that they wrote.
An investor who buys a call:
[B] has the right to buy 100 shares of the underlying stock. EXPLANATION Investors who buy calls have the right to buy (call away) 100 shares of the underlying stock. Sellers of options are obligated to perform in the event that the buyer of the option decides to exercise. The right to sell 100 shares of the underlying stock is given by purchasing a put option.
Which of the following would be considered an Over-the-Counter (OTC) transaction?
[C] An equity option transaction between a buyer and seller away from an exchange EXPLANATION Securities transactions that take place outside of a designated exchange would be considered Over-the-Counter (OTC). This is the case even when the securities in question are derivatives or pooled investment products. Transactions on the NYSE, PHLX, or AMEX would be considered "listed", which is a reference to the fact that securities must meet listing standards to be traded on these exchanges.
A corporation that has agreed to accept payments in Euro Currency would hedge by which of the following option positions?
[C] Buying puts on the Euro Currency EXPLANATION Since the corporation will be paid in Euro Currency they would want to be protected from a decline in the value of the Euro and would therefore either sell calls or buy puts on the Euro.
A put writer would be "covered" by:
[C] Cash equal to the strike price multiplied by 100 shares EXPLANATION A covered put option gives the investors the obligation to Buy. The writer (short) needs to have sufficient cash on deposit, have long equivalent put, or have a bank guarantee letter to "cover" the put if exercised by the holder.
A customer with a long option position sells an option in the same series. This is referred to as a:
[C] Closing sale EXPLANATION A closing sale offsets an opening purchase.
Which of the following represents the most conservative option strategy?
[C] Covered call writing EXPLANATION Covered call writing is considered the most conservative option strategy. In contrast, uncovered call writing is the most speculative strategy.
Which of the following is synonymous with the term "Strike Price"?
[C] Exercise price EXPLANATION The strike price on an option contract is the price at which the contract will be exercised if the buyer chooses to exercise the contract. It is also referred to as the exercise price. Market price is related to the value of a security during the trading day, closing price is tied to the price at which a security closes at the end of the trading day, and breakeven price is a reference to the point at which an investor has no gains or losses associated with a position.
An investor buys 100 shares of ABC common stock at 25. If the investor later buys a put on ABC, he/she has:
[C] Hedged against a price decline EXPLANATION A hedge is a security transaction that reduces the risk on an already existing investment position. Buying a put offsets the potential losses from a long stock position.
All of the following cover the sale of a call option under option exchange rules, EXCEPT:
[C] One convertible bond that converts to 50 shares of the underlying stock EXPLANATION Each of the answers listed would cover a call that was sold except for the convertible bond that only converts to 50 shares of the underlying stock. Remember that a standard/traditional option contract is for 100 shares of the underlying security, so coverage with a convertible bond that converts to 50 shares would require two of the bonds.
Which of the following entities provides a physical and electronic location where listed options transactions are performed during trading hours in the U.S.?
[C] The Chicago Board Options Exchange (CBOE)
Which of the following investment strategies is BEST suited for an investor who believes that the market will have large amounts of volatility in the coming months, but that despite the volatility, the market will remain stable or only go down slightly?
[C] The investor should purchase call options on VIX. EXPLANATION VIX options are a barometer of near-term investor sentiment. VIX stands for Volatility Index Options. The VIX moves in the opposite direction of the S&P 500 approximately 88% of the time, so this investor should buy VIX call options since they will appreciate with a decrease in market value, and since the volatility may increase their value.
An investor would have the greatest amount of risk with which of the following option positions?
[C] The investor writes an uncovered call. EXPLANATION The writing of an uncovered call has unlimited loss potential, therefore it would have the greatest risk.
Which of the following is true upon the exercise of a short put?
[C] The writer is required to accept delivery of the underlying stock. EXPLANATION Put writers are obligated to buy (accept delivery) of the underlying stock.
Each of the following are reasons for buying a listed put option on an exchange as opposed to selling short the underlying stock, EXCEPT
[C] any time-value in the put gradually dissipates as it approaches expiration. EXPLANATION Although "C" is a true statement it is not a reason for buying a put rather than selling stock short.
An investor who is "bullish" should invest in all of the following EXCEPT:
[C] sell naked calls EXPLANATION A "bullish" investor expects the market to rise. Therefore, the investor should buy stock or buy the call option. The investor could also sell puts because the buyer won't exercise the option if the price of the underlying stock goes up and the investor can keep a premium. A bullish investor should not sell or write calls because the holder will exercise the option against the investor in an "up" market. The potential risk or reward of naked positions is greater than that of covered positions.
An option trader buys 1 ABC April 25 put. A few months later, the trader exercises the option. The trader's net sales proceeds equal the:
[C] strike price minus the premium EXPLANATION The investor will exercise the option to sell at the strike price. The gross sales proceeds must be reduced by the amount of the premium to arrive at the net sales proceeds.
The purchaser of a call option would have which of the following? I. A leveraged position II. Protection against a short stock position III. Limited risk
[D] All EXPLANATION Buying a call option allows the investor leverage because they could buy more options than shares of stock with the same amount of money. If you sell stock short you expect the market price of the stock to go down, but if it goes up you would be losing money and you could exercise you long call, buy the stock from the exercise and then use that stock to cover you short stock position. When you buy a call you have limited risk because the most you can lose is the premium you paid to buy the call.
The value of an equity option is affected by which of the following? I. The volatility of the underlying security. II. The liquidity of the underlying security. III. Changes in interest rates. IV. The relationship between the strike price and the market price of the underlying security.
[D] All EXPLANATION The value of an option, or premium, is affected by the volatility of the underlying security and reacts to changes in interest rates as the market price of the stock changes. Premiums are affected by the liquidity of the underlying security. Options can be more liquid than the security itself, due to the trading volume in options.
Which of the following would influence the price of option premiums?
[D] All of these items influence the price of option premiums EXPLANATION The market price of an underlying security, the amount of time until the contract expires, and the volatility of the underlying stock's price would all have a direct influence on the premiums of the option contracts.
At what time must a firm provide an Options Disclosure Document (ODD) to a customer?
[D] At or before the approval of the account for options trading. EXPLANATION Options regulations specify that an Options Disclosure Document (ODD) must be delivered to a customer at or prior to the time that the customer's account is approved for options transactions.
Intrinsic value for an option is defined as the:
[D] Difference between the stock's market price and option strike price, if exercise would be profitable to the holder in a long position. EXPLANATION A call is in-the-money when the market price is above the strike price. A put is in-the-money when the market price is below the strike price. Therefore, in-the-money can be defined as the difference between the market and strike prices on a profitable option.
A trader buys an ABC June 40 call for 3 when ABC stock is trading at 35. If the stock rises to 50 and the trader exercises the call, which of the following is true:
[D] He owns a stock with a cost basis of $43 per share EXPLANATION Premiums Stock Trans. buys 1 ABC June 40 call for 3 B - 300 exercises the June 40 call B - 4,000 Net Debit - 300 - 4,000 \ / - 4,300 He owns a stock with a cost basis of 4300 / 100 shares = $43 per share
Which of the following are true of the seller of a put option? I. The maximum loss is limited. II. The maximum gain is unlimited. III. The maximum loss is limited to the premium. IV. The maximum gain is limited to the premium.
[D] I and IV EXPLANATION Choice IV is correct because the most you can make from the sale of the option -- limited profit. Choice I is correct. Because the strike price is fixed, you would know at what price you would be required to acquire the index -- limited loss.
Which of the following influence the premiums of a listed option? I. the time remaining until the expiration of the contract. II. the market price of the underlying stock. III. the volatility of the underlying stock. IV. interest rates.
[D] I, II, III and IV EXPLANATION All choices would affect the premium value of an option.
For position limit reporting purposes which of the following must be aggregated? I. Long calls and short calls II. Long puts and short puts III. Long calls and short puts IV. Long puts and short calls
[D] III and IV EXPLANATION Industry rules require that member firms report to FINRA each account that has 200 or more option positions. These positions must be aggregated on the same side of the market as answer D shows.
Which two of the following are true for the buyer of a put option? I. The profit potential is unlimited. II. The maximum loss is unlimited. III. The profit potential is limited. IV. The maximum loss is limited.
[D] III and IV EXPLANATION Choice III is correct because the buyer of put expects the market price to decline, and the lowest it can decline is to 0 -- limited profit. Choice IV is correct because the most you can lose when you purchase an option is the premium paid -- limited loss.
A customer buys 100 shares of XYZ at $60 per share and buys 1 XYZ October 60 put at 4. Which of the following statements is true?
[D] Maximum Profit - $6,400; Maximum Loss - Unlimited EXPLANATION The profit would be unlimited because you would be long the stock and the loss would be limited to the premium paid to buy the put ($400). By buying the put, you lock in a price (60) at which you could sell the stock.
All of the following are advantages to call buyers EXCEPT:
[D] Premium EXPLANATION Paying a premium is not advantageous to the buyer of an option.
Mr. Jones thinks that the market price of ABC will remain stable or decline modestly in price and is looking for increased income. Which of the following option positions would be best for Mr. Jones?
[D] Short Calls EXPLANATION When an investor is looking for "income," their first choice would be to become a writer of an option. Short Calls would be used if the market is expected to remain stable or decline modestly.
Although a new options account was approved for options trading by the firm's registered options principal on July 10, on July 26, the customer still has failed to return a signed options agreement. Which of the following is correct regarding the account?
[D] The customer should be allowed to close existing options positions, but not open any new options positions. EXPLANATION Should the client fail to return a signed options agreement, the account would be allowed to close existing positions, but would not be allowed to open any new ones.
One of your clients has a long-term holding in BCD Corporation's common stock. The client anticipates that there will be no substantial movement in the market value of BCD in the near future. The client wants to bring in some additional funds on top of their retirement plan distributions. With the above information in mind, which of the following would be the MOST appropriate way to accomplish this goal?
[D] The customer should start selling call options on BCD Corporation Stock. EXPLANATION Since the customer owns BCD stock already and expects no substantial movement in BCD stock, a conservative way to generate income from options premiums would be to sell call options on BCD. This would mean that the investor was selling covered calls.
An investor buys a call option on a common stock. Theoretically, what is the MOST that the investor could gain on this investment?
[D] The potential gain is unlimited. EXPLANATION When an investor buys a call option they expect the market price of the stock to go up. Since there is no limit as to the possible appreciation of the underlying stock, the profit potential is unlimited on a purchased call. The answer would not be the difference between the strike price and the market value, because this does not take into consideration the premiums paid, or the possible appreciation of the underlying securities prior to expiration of the call option.
An investor buys 100 shares of ABC stock for $50 per share. He also buys one ABC January 50 put for a premium of $5. What is the maximum profit that the investor can make at expiration of the option?
[D] Unlimited EXPLANATION Since the investor is long the stock, the investor would have unlimited profit potential.
The option premium is the
[D] cost of the option to the buyer. EXPLANATION The option premium is the price the buyer pays to purchase the option.
