04.1 Options Flashcards
How far is a MSFT Jan 90 call In the money with MSFT trading at $85?
A. $0
B. $5
C. $87.50
D. $90
A. $0
Rationale:
The stock is worth $85–the option would let you buy it for $90. Sound good? No. It’s out of the money by $5.
How far are the IBM Aug 70 calls in the money if IBM trades at $77?
A.$0
B. $7
C. $77
D. $10
B. $7
Rationale:
You can “call up” by $7 from the strike price to the market price, so the call is in the money by $7.
An investor is long an IBM Mar 90 call @3. With IBM @94.75, the investor closes the option for its intrinsic value. He has a:
A. Loss of $175
B. Gain of $475
C. Loss of $300
D. Gain of $175
D. Gain of $175
Rationale:
His breakeven point is $93, so he makes anything above and beyond $93.
An investor sold an IBM Mar 90 call @3. With the underlying security trading @92, she closes the contract for its intrinsic value. She has a:
A. Gain of $9,000
B. Gain of $100
C. Loss of $9,000
D. Loss of $100
B. Gain of $100
Rationale:
For a seller find the breakeven point. If the stock fails to reach the breakeven point, the seller wins. The amount that it fails to reach the breakeven point is the amount that the seller makes.
A MSFT Jun 65 put @3 has how much intrinsic value with MSFT @65?
A. $2
B. $65
C. $3
D. $0
D. $0
Rationale:
Options that are at the money have no intrinsic value. There is only intrinsic value when the option is IN the money; in fact “in-the-money” and “intrinsic value” are synonymous. Does it have intrinsic value? If so, it’s in the money, and the amount that it’s in the money IS the intrinsic value.
An IBM Mar 75 put @3 has how much time value with IBM
@74?
A. $0
B. $1
C. $2
D. $3
C. $2
Rationale:
The option is in the money by $1 (intrinsic value). The other $2 in the premium, then, is called time value.
An investor writes an XYZ Mar 75 put @4. With XYZ @74, he closes the contract for its intrinsic value. He has a:
A. Gain of $400
B. Gain of $100
C. Gain of $300
D. Loss of $400
C. Gain of $300
Rationale:
This type of option question really involves just two steps. Step one, put the premium they give you in the correct side of your T- chart. In this question put “4” in the credit column, because all sells/writes/shorts go in the credit column. Step two is to find the intrinsic value of the option and write it on the opposite side of the T-chart. Intrinsic value of a 75 put with the stock down at $74 is that difference, $1. So write $1 in the debit column and you see there is a $3 per-share gain.
An investor sells an IBM May 80 put @3.50. With IBM @78, she closes the option for intrinsic value. She has a:
A. Gain of $350
B. Loss of $350
C. Loss of $150
D. Gain of $150
D. Gain of $150
Rationale:
The stock failed to reach the breakeven point by $1.50, so that’s what the seller makes.
What is the breakeven on an XYZ Feb 75 put @2.50?
A. $77.50
B. Depends on whether the investor bought or sold this option
C. $75.00
D. $72.50
D. $72.50
Rationale:
Buyers and sellers ALWAYS breakeven at the same price. For puts, that would be: strike price minus premium.
With XYZ trading @52.50, which of the following options is in the money?
A. XYZ Mar 55 call
B. XYZ Mar 55 put
C. XYZ Mar 50 put
D. XYZ Mar 45 put
B. XYZ Mar 55 put
Rationale:
A Mar 55 put would allow you to sell a $52.50 stock for MORE than it is actually worth.
Tom sold an ARQ Mar 65 put @3. With ARQ @60, Tom receives an assignment notice. He ends up with a:
A. Loss of $300
B. Gain of $20
C. Gain of $300
D. Loss of $200
D. Loss of $200
Rationale:
Takes in 3 and pays out 5. It’s really as simple as that.
A MSFT Jun 50 call @1.50 is in the money as soon as MSFT trades above:
A. $48.50
B. $50.00
C. $49.00
D. $51.50
B. $50.00
Rationale:
Don’t confuse “in the money” with “breakeven”. The breakeven point might be $51.50, but that’s not what the question asked. The question asked when a call with a strike price of $50 is in the money. Above $50. Call UP.
What is the intrinsic value of a MSFT Jan 90 call @1.45 with MSFT common stock trading at $85?
A. $6.45
B. Zero
C. $5.00
D. $86.45
B. Zero
Rationale:
How could a “90” call be in the money if the stock is only trading at $85?
With MSFT trading at 83.12, MSFT Aug 80 calls @4 are:
A. Not enough information given in the question
B. In the money
C. Out of the money
D. At the money
In the money
Rationale:
Don’t confuse “in the money” with “breakeven”. Breakeven is a very personal matter. Ten different buyers could have ten different breakeven points on the same option series. It depends on what they paid for the call or put. One guy pays $1 for a June 50 call, another pays $2 for the same call. Thafs two different breakeven points. But it has nothing to do with whether the option is in the money. A call is in the money as soon as the stock is higher than the strike price, end of story. As soon as the stock goes above $80 in this question, the call is in the money.
When may an American style option be exercised?
A. Anytime after expiration
B. At 1159 PM on the 3rd Friday , following the third Saturday of the month
C. Only upon expiration of the contract
D. Any time up to expiration of the contract
D. Any time up to expiration of the contract
Rationale:
Associate the “A” in “American” with the “a” in anytime.” Associate the UE “ in “European” with the “e” for
“expiration.” As if you didn’t already have enough stuff to remember.
Your customer owns 100 shares of MSFT. To generate income, he should:
A. Buy a put
B. Buy a call
C. Sell a put
D. Sell a call
D. Sell a call
Rationale:
To generate income you have to sell/write/short something. If you’re bullish on the stock, sell the bear position bears sell calls. Now, if your stock goes up, you make money on the stock. And, if the stock goes the other way, at least you made the premium and let the call expire.
Your customer is short 100 shares of MSFT. For best protection, he should:
A. Sell a call
B. Sell a put
C. Buy a call
D. Buy a put
C. Buy a call
Rationale:
To best protect a stock position you have to buy an option. You’re bearish on the stock, so you bet the other way with an option—buy a call.
Your customer is short 100 shares of MSFT. To increase yield, he should:
Rationale: A. Buy a put B. Sell a call C. Buy a call D. Sell a put
D. Sell a put
Rationale:
To increase yield/return you have to sell an option. If you’re bearish on the stock (short), you sell the bull position—bulls sell puts.
An investor who is short stock gets protection when she:
A. Sells a put
B. Sells a call
C. Buys a call
D. Buys a put
C. Buys a call
Rationale:
“Protect” means buy. Short stock, so go the other direction with the option buy a call.
Long 100 shares XYZ @40. Short XYZ Oct 50 call @2.25.
What is the maximum loss in this hedged position?
A. 12.25 per share
B. Unlimited
C. 37.75 per share
D. 10.00 per share
C. 37.75 per share
Rationale:
Many students assume that if you sell a call, you will end up selling stock at that price. No. Only if the stock goes ABOVE the strike price. If the stock goes the other way, that call you sold is history, worthless, forgotten. You’re on your own now, Mr. Covered Call, suffering like any other stock buyer. If that stock drops from $40 to zero, you lose $40, just like the rest of us. Oh yeah, you did take in S2.25 a share in call premiums, you lucky Devil.
An investor is short a MSFT Jun 60 put. Which position would complete the straddle?
A. Long MSFT Jun 50 call
B. Short MSFT Jun 50 put
C. Long MSFT Jun 50 put
D. Short MSFT Jun 60 call
D. Short MSFT Jun 60 call
Rationale:
In a straddle, both lines look exactly the same only
difference is one is a put, the other is a call.
An investor anticipating volatility buys an XRQ Oct 60 call @4 and an XRQ Oct 60 put @3. If XRQ is trading @54 at
expiration and the investor closes both positions for their intrinsic value, what will be his gain or loss?
A. $100 loss
B. $700 loss
C. $700 gain
D. None of the choices listed
$100 loss
Rationale:
The investor paid total premiums of $7, so the breakevens are $7 above and $7 below the strike price of 60.
He would have been even at $53, but the stock only made it to $54, which is why he loses $1 per share, or $100 total.
An investor who anticipates stability, sells a Jun 90 call @4 and a Jun 90 put @3.50. He closes both positions for their intrinsic value at expiration, when the underlying stock is trading at $111. What is the investor’s gain or loss per share?
A. $13.50 gain
B. Unlimited
C. $13.50 loss
D. $5 loss
C. $13.50 loss
Rationale:
The seller takes in $7.50, so he wont lose unless the stock moves up or down by more than $7.50. The stock moved up by $21, so he loses the difference between $21 and
$7.50, or $13.50 per share.
An investor purchased shares of XYZ @50. XYZ now trades at $58. The investor feels that the stock will not rise over the next several weeks. Therefore, you recommend that he:
A. Sell near-term XYZ puts
B. Sell near-term XYZ calls
C. Buy near-term XYZ calls
D. Purchased near-term XYZ puts
B. Sell near-term XYZ calls
Rationale:
Perfect time to sell a covered call—you’re convinced the stock is going nowhere, but somebody is willing to bet you otherwise.
An investor feels that ABC is headed for a sharp decline.
Therefore, this investor might do all of the following except:
A. Purchase ABC straddles
B. Write ABC calls
C. Sell ABC short
D. Purchase ABC puts
A. Purchase ABC straddles
Rationale:
In anticipation of a market decline, speculators buy puts, sells calls, and sell stock short. If you expect a stock to drop, why buy the call that’s included in the straddle? A straddle is purchased when the speculator does not want to make a directional bet. If he felt he could call the direction, he would not waste money on the other option
that makes the thing a straddle.
Long IBM Mar 90 call. Short IBM Mar 100 call. The investor will profit if the difference in premiums:
A. Narrows
B. Elongates
C. Widens
D. Changes
C. Widens
Rationale:
Debit = widen. The investor bought the more valuable call, so he has a debit spread. The right to buy at 90 is more
valuable than the right to buy at 100, yes?
Long IBM Mar 90 call @6. Short IBM Mar 100 call @2. What is the investor’s max loss and max gain, respectively?
A. 6, 2
B. 2, minus initial debit
C. 2, 6
D. 4, 6
D. 4, 6
Rationale:
The investor starts with a debit of4,so4isallhecanlose. The max gain and max loss always add up to the difference in strike prices (10), so the other number is 6. This was the only choice where the gain and loss added up to 10, so it had to be the right answer.
What is the breakeven for the following position?
Long ORCL May 30 call @3.30
Short ORCL May 20 call @6.50
A. $23.50
B. $9.80
C. $23.20
D. $2.20
C. $23.20
Rationale:
Take the difference in premiums, $3.20, and add that to the lower strike price. For call spreads add the net premium to the lower strike price, just like this.
What is the breakeven for the following position?
Long ORCL May 30 put @4.50
Short ORCL May 20 put @1.90
A. $2.60
B. $27.40
C. $6.40
D. $22.60
B. $27.40
Rationale:
Take the difference in premiums, $2.60, and subtract that from the higher strike price. For put spreads subtract
the net premium from the higher strike price to get the breakeven.
The investor will profit if the difference in premiums:
Short IBM Mar 90 call
Long IBM Mar 100 call
A. Elongates
B. Narrows
C. Widens
D. Achieves parity
B. Narrows
Rationale:
Credit = narrow, expire. The investor sold the more valuable call, so he starts with a credit. The right to buy at 90 is worth more than the right to buy at 100.
A MSFT Jun 50 call is in the money when MSFT trades at which of the following prices?
A. $48.00
B. $51.00
C. $49.00
D. $50.00
B. $51.00
Rationale:
A call is in the money when the market price of the stock is
higher than the strike price of the call. We could also say that a call is in the money when the strike price is lower than the market price.
What is the maximum loss on this position?
Long 100 shares XYZ @55
Long XYZ Mar 50 put @2.25
A. None of the choices listed
B. $500
C. $725
D. $275
C. $725
Rationale:
This is basically an insurance policy with a $500 deductible and a $225 premium. If you buy at $55 and sell at $50, you can lose $500. Your premium isn’t coming back, either, just like in an insurance policy.
If an investor has sold an XYZ Nov 50 put, which of the
following positions will complete the straddle?
A. Sell XYZ Nov 50 call
B. Sell XYZ Nov 50 call
C. Buy XYZ Nov 50 call
D. Sell XYZ Dec 50 call
A. Sell XYZ Nov 50 call
Rationale:
Every item in both lines is the same, except one is a call, the other a put.
Long IBM Mar 70 call @4. Short IBM Mar 60 call @8. The maximum loss on this position is:
A. Unlimited
B. $1,000
C. $400
D. $600
D. $600
Rationale:
The maximum gain is the $4 per share that the investor starts out with in his credit column. The difference in strike prices, $10, minus that $4 gives you your answer-$6 per share or $600 total. For a spread, your answer could
never be “unlimited”
Buy 1 IBM Mar 70 call @4. Sell 1 IBM Mar 60 call @8. The
maximum gain on this position is:
A. $600
B. Unlimited
C. $400
D. $1,000
C. $400
Rationale:
If you start with a credit of $4 per share, that’s all you can make.
Buy 1 XYZ Oct 50 call @2. Buy 1 XYZ Oct 50 put @2. This
position will prove profitable if XYZ trades above which price?
A. 45
B. 53
C. 54
D. 46
C. 54
Rationale:
The breakeven points are $4 above and below 50. $54 would be a breakeven, so above $54 would be a gain. Remember that buyers don’t make money unless and until
the stock goes beyond the breakeven point. $46 was the other breakeven, but the stock has to be below—not above—that for the position to be profitable.
