Wealth II - Chapter 15 Derivatives Options (Money Education)

An investor buys 1 ZZZ Dec 95 call at $5. When ZZZ increases to 99, the call is exercised and the stock is immediately sold. What is the result?

($4 gain from stock price x 100 shares) - ($5 premium paid x 100 shares) = Loss of $100

Rascal has entered into a contract to buy 100 shares of Rally stock for $40 per share anytime over the next six months. He has a:

- Long position in a call option. A call option gives the holder the right to purchase the underlying security at a specific price within a specific period of time

Jack owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion ratio equals: A

25; The conversion ratio equals the number of shares of common stock that the bondholder will receive if the bond is converted.

Clarissa holds a concentrated position in XYZ stock, which she purchased 15 years ago for $6 per share. The price of XYZ stock is currently at $100 per share, and Clarissa is happy with the gain that she has achieved. She realizes that it is a good idea to diversify her portfolio, but selling all of the stock in the current year will result in a large tax burden. Which of the following strategies would allow Clarissa to sell some of the shares this year, and delay selling some of the shares until next year to help ease the tax burden, but will lock in her sale price within a reasonable range of the current price?

A collar strategy involves the simultaneous purchase of a put option and sale of a call option, with the same expiration but different strike price. For example, Clarissa might be able to purchase a put option with a strike price of $90 that expires next year in February, by paying a premium of $4. At the same time, she may be able to sell a call option with a strike price of $105 that expires in February of next year, and receive a premium of $4. This would be called a "zero cost collar" since the premium she paid for the put is exactly offset by the premium she received for writing the call. In February of next year, if the price of XYZ stock has risen above $105, the holder will exercise and Clarissa will sell at $105. If the price falls below $90, Clarissa will exercise her put option and sell at $90. She has "collared" her sale price between $90 and $105 for the next tax year.

A contract that gives its owner the right to sell a specified asset at any time prior to expiration is called:

A put option contract - Options give the holder the right to either buy or sell. A put option gives the holder the right to sell the underlying asset (generally stock) at the strike price. Futures and forward contracts are designed to make or take delivery at a specified period of time in the future

Which of the following option positions represents the most risk to an investor?

A short straddle is a short call combined with a short put on the same underlying security, each having the same strike price and exercise month. With a short straddle, the investor makes money if the stock price remains constant. The investor can lose if the stock price decreases or increases. The larger the price change, the larger the loss. If the market price of the underlying stock increases, the short call can be exercised against the investor. Because the stock price can increase without limit, the short straddle has unlimited loss potential.

An "at the money call":

An "at the money call" is strike price equal to the market value, which is an intrinsic value of zero.

Beau buys 10 DEF 65 call options for $7 when the price of DEF is $61. Beau sells the call options for $16. What is his gain or loss?

Beau bought the calls for $7,000. Remember, 1 option contract represents 100 shares of stock. He sold the calls for $16,000. Therefore, his gain equals $9,000.

Gerry expects the market to rise. Which of the following option strategies should he follow: 1. Long call 2. Long put 3. Short call 4. Short put.

Long a call (buy), short a put (sell).

Mike believes that XYZ stock will increase in value. He buys 20 XYZ March 60 call options for $4 when the price of XYZ is $61. If XYZ falls to $55 and stays there through March, what will be Mike's gain or loss?

Mike paid $8,000 (2,000 options x $4). $8,000 is the premium paid and is the maximum loss if the contract expires.

Which of the following positions has the greater risk for investors?

Shorting a stock - The maximum loss for a long call is the premium paid. The risk for a covered call is to lose the stock, which is a loss of upside potential. A covered put involves writing a put for a stock that has been sold short. The put premium offsets some of the downside risk. The short sale of a stock is the riskiest position since the short seller must repurchase the stock in the open market if the stock price increases

An investor buys 100 shares of XYZ stock for $40 and simultaneously writes 1 XYZ November 40 call at $3. If the investor closes both positions three months later when the XYZ is trading at $45 and the November calls are at $6, what is the result?

Stock position 100 x ($45-$40) = $500 Option position ($6-$3) x 100 = ($300) $500 - $300 = $200

Jack owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion price equals:

The conversion price equals the par value of the bond ($1,000) divided by the conversion ratio (25), which equals $40.

A put option is available on the stock of Rally Corporation. The exercise price is $65. The put option price is $1. Rally stock is currently selling for $70 per share. What is the "intrinsic value" of the put option?

The intrinsic value is the minimum value an option will trade for and equals the strike price minus the FMV of the stock for a put option. In this case, the intrinsic value equals $0 ($65 - $70) - it cannot be less than zero. The intrinsic value is not influenced/impacted by the option price.

Regarding a short straddle

The maximum loss is unlimited -A short straddle consists of a short put and short call. Gain is limited to the premiums. Losses are unlimited on the call side

Harris buys 20 call options on XYZ March 60 for $5 when the price of XYZ is 61. XYZ falls to $40 and remains there through March. What is Harris's gain or loss?

The options will expire worthless and Harris will lose the premium paid for the options.5 x 2 options x 100 shares = 10,000 Loss

For a call option contract, the price at which the option holder can buy the underlying security is called?

The price at which a call option holder buys the underlying stock is called the exercise price or the strike price.

What is the investor's strategy for profit if he buys 1,000 shares of LMT stock at $71 and also 10 LMT July puts at $2?

The put is to protect the downsides risk. He is bullish because he is long the stock.

A writer of a call option:

The writer of a call option is the seller of the option and receiver of the option premium.

When someone "writes" a call option, he has:

The writer receives the option premium for selling the call options.

What is the investor's strategy for profit if he buys one ABC July 60 call at $3 and buys one ABC July 50 put at $1?

Volatility - Volatility increases the value of options

If a farmer buys a wheat put option on futures:

Wheat options are option contracts in which the underlying asset is a wheat futures contract. The holder of a wheat option has the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying wheat futures at the option strike price. This right expires when the option expires after market close on expiration date.

Writing a call option on the S&P 500 Index results in:

Writing a call option on the S&P 500 index results in a premium to the writer. The writer loses money if the index increases. The writer's maximum gain (premium) results if the price of the index decreases