Unit 10: Qbank

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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 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.

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?

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 four points. Therefore, 4 plus 40 equals 44.

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

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 is long an ABC Apr 40 call and is short an ABC Jul 40 call. Which of the following best describe his position? Bullish Bearish Calendar spread Vertical spread

The July call will have a higher premium than the April call because it has more time value. Because 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. Therefore, this customer's position is bearish. Because the options expire in different months, the trade is a calendar spread.

An investor is short stock at 60. The current market price of the stock is 33, and the investor anticipates it will continue to decline. If the investor would like to generate income but still benefit if the stock continues to fall, which of the following positions would do that?

This investor selling a 35 call will collect the premium and would profit if the price continues to fall. However, the investor is still exposed to unlimited financial risk. If the price goes up and the call is exercised, the investor is obligated to buy stock to deliver at 35, regardless of the cost in the market because this would be an uncovered call. In essence, this investor has unlimited loss from two positions; the short stock and the uncovered call. Why not buy a call to protect the short stock position? Good idea, but note that the question states the investor would like to generate income. The only way one can generate income with options is to sell them (be a writer). Buying a put would be like "doubling down". The investor already made the bearish bet by selling short. Buying the put is the same bet (and does not generate income).

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

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.


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