04.2 Options

Question 1

How much time value is represented in the following premium?

MSFT Oct 65 put @7.45
with
MSFT@72.00

A. $.45
B. $7.00
C. $0
D. $7.45

Answer 1

D. $7.45

Rationale:
It’s all time value. The option is out of the money, so the whole $7.45 is time value. That option wouldn’t have intrinsic value unless the stock fell below $65.

Question 2

MSFT Jan 80 calls are trading for 4.25 with the underlying instrument trading at 82. Therefore, which of the following statements is/are correct?

A. The calls are out-of-the money
B. The calls have no time value
C. The calls are in-the-money
D. The calls have no intrinsic value

Answer 2

C. The calls are in-the-money

Rationale:
The calls are definitely in the money—by $2—so two choices are knocked out with one punch.

Question 3

What is the maximum gain for the following position?

Short 3 Apr 90 puts @2

A. $200
B. $6,000
C. Unlimited
D. $600

Answer 3

D. $600

Rationale:
A seller can only make the premium collected. $600. If
you chose “$200”, you forgot to multiply the premium by the number of contracts.

Question 4

What is the maximum loss for the following position?

Long 3 May 80 puts @2

A. $6,000
B. $600
C. $200
D. Unlimited

Answer 4

B. $600

Rationale:
Buyers can only lose what they pay. $200 per contract times 3 contracts.

Question 5

An investor who owns stock stock would receive best protection if she:

A. Bought puts
B. Sold calls
C. Bought calls
D. Sold puts

Answer 5

A. Bought puts

Rationale:
To protect you have to buy. Buying a put allows him to sell the stock for a CERTAIN price, even if the actual price were to drop to zero.

Question 6

An investor who owns shares of stock wants a partial hedge that will increase his overall return. He should:

A. Buy puts
B. Sell calls
C. Sell puts
D. Buy calls

Answer 6

B. Sell calls

Rationale:
To increase return or take in income, you have to sell. He’s
long stock, so he sells the bear position. Sell a call. A covered call, since he’s got the stock. If it gets called away, no problem. He already bought it, probably at a price cheaper than the strike price of the call.

Question 7

An investor who has sold stock short would get the best protection by doing which of the following?

A. Selling calls
B. Selling puts
C. Buying puts
D. Buying calls

Answer 7

D. Buying calls

Rationale:
He has to cover the short stock position; buying a call lets him name the price he has to pay to do that.

Question 8

An investor short stock wants to increase yield. She should:

A. Sell puts
B. Sell calls
C. Buy calls
D. Buy puts

Answer 8

A. Sell puts

Rationale:
Short stock is bearish, so the hedge points the other way sell a put or buy a call. To increase yield/income, you sell. Sell a put. Buy a call to protect; sell a put to increase income/yield.

Question 9

Which of the following positions represents a spread?

A. Long XYZ Nov 30 call, short XYZ Nov 40 put
B. Long XYZ Nov 70 put, short XYZ Nov 60 put
C. Long XYZ Oct 50 call, short XYZ Oct 40 put
D. Long 10 XYZ Oct 50 calls, short 10 MSFT Oct 60 calls

Answer 9

B. Long XYZ Nov 70 put, short XYZ Nov 60 put

Rationale:
One choice might look like a spread, but upon closer examination we see that there are two different underlying
securities involved—XYZ and MSFT. Only one choice is a spread, which involves buying and selling calls or buying and selling puts on the same underlying stock.

Question 10

Which of the following positions is bullish?

A. Short XYZ Dec 20 put, long XYZ Dec 30 put
B. Hold XYZ Oct 30 call, write XYZ Oct 20 call
C. Short XYZ Jan 40 call, long XYZ Jan 30 call
D. Buy DFZ Sep 100 put, write DFZ Sep 90 put

Answer 10

C. Short XYZ Jan 40 call, long XYZ Jan 30 call

Rationale:
It’s a B-U-L-L spread “Because U are Long the Lower” strike.

Question 11

What does an investor with the following position need in order to profit?
Long XYZ Oct 40 call
Short XYZ Oct 50 call

A. Difference in premiums narrows
B. Both options expire
C. Both options go in the money/are exercised
D. Difference in strike prices widens

Answer 11

C. Both options go in the money/are exercised

Rationale:
This investor would love both options to be exercised, which would force him to sell the stock at $50, but he gets to buy it at $40. Nice work if you can get it.

Question 12

Your customer has established the following options position.
Long 1 ABC Mar 60 call @5.00
Short 1 ABC Mar 70 call @2.00

This position will prove profitable if, at expiration:
I. The spread has narrowed to less than 3
ll. The spread has widened to more than 3
III. ABC stock is below 63
IV. ABC stock is above 63

A. I, IV
B. II, IV
C. II, III
D. l, III

Answer 12

B. II, IV

Rationale:
Now that’s a Series 7 question! It’s coming from two different angles. The first angle is to determine if it’s a credit or debit spread. Then again, the question tells you what he paid and received, so that was a given. He paid more than he received—debit spread. D-E-B-l-T = W-l-D-E-N. The other concern is whether it’s bullish or bearish. Find the break even point of 63. You do that by adding the net premium of 3 to the lower strike price. 60 + 3 = 63. Since he’s a bull, he wants it to go UP above that breakeven point. Buyers always want the stock to go beyond the breakeven point; sellers want the opposite.

Question 13

Logan is long an ABC Mar 55 put @3.50. Logan’s long option position will be in the money as soon as ABC trades:

A. At $55
B. Above $55
C. Below $55.00
D. Below $51.50

Answer 13

C. Below $55.00

Rationale:
Put DOWN. When the stock is DOWN below the strike price, the put is in the money.

Question 14

Which of the following statements is/are true?

I. Options transactions settle next business day
II. Options transactions settle T+3
III. Put writers must deliver the underlying stock next business day
IV. Put writers must deliver the underlying stock T+3

A. II, IV
B. I, III
C. I
D. I, IV

Answer 14

C. I

Rationale:
Options settle next business day. Why would a put writer deliver stock?

Question 15

Identify the following position:
Long ABC Jul 30 call @3.00
Short ABC Jul 20 call @5.25

A. Price spread
B. Long straddle
C. Short straddle
D. Time spread

Answer 15

A. Price spread

Rationale:
It’s definitely a spread, since he’s long and short calls on the same stock. The difference between the two options is the strike price, so it’s a “price spread.”

Question 16

Identify the following position:
Long ABC Jul 30 call @3.00
Short ABC Jul 20 call @5.25

A. Bull spread
B. Straddle
C Debit spread
D. Bear spread

Answer 16

D. Bear spread

Rationale:
It’s not a straddle. Straddles are long-long or short-short, no exceptions. It’s clearly not a debit spread, since he’s taking in more than he’s spending. He is not long the lower strike, so it’s a bear spread.

Question 17

Identify the following position:
Long ABC Jul 30 call @3.00
Short ABC Jul 20 call @5.25

A. Bull spread
B. Straddle
C. Diagonal spread
D. Credit spread

Answer 17

D. Credit spread

Rationale:
The question told you he took in more than he spent. If you didnt choose credit spread, you’re tired and need a break.

Question 18

A customer bought an ABC Mar 55 call @3.50. The option will be in the money as soon as ABC trades:

A. Below $55
B. Above $55
C. Above $58.50
D. At $55

Answer 18

B. Above $55

Rationale:
Call UP. If the stock is UP above the strike price, the call is in the money. If you chose “$58.50” you were thinking
about the breakeven point. Save that for a question that asks you about the break-even point.

Question 19

Which of the following is a “diagonal spread”?

A. Long Oct 30 put, Short Nov 40 put
B. Long Oct 30 put, Short Nov 30 put
C. Long Oct 30 call, Short Oct 40 call
D. Long Oct 30 put, Short Oct 45 put

Answer 19

A. Long Oct 30 put, Short Nov 40 put

Rationale:
Diagonal spreads involve different strike prices and different expiration months.

Question 20

Which of the following is a credit spread?

A. Long May 45 put, Short May 40 put
B. Long Jul 25 call, Short Jul 20 call
C. Long Jul 25 call, Short Jul 35 call
D. Long Jun 45 put, Short Jun 35 put

Answer 20

B. Long Jul 25 call, Short Jul 20 call

Rationale:
If the investor buys the more valuable option, it’s a debit spread. If she sells the more valuable option, that’s a credit spread.

Question 21

Which of the following is a debit spread?

A. Long Mar 30 put, Short Mar 35 put
B. Long Mar 30 call, Short Mar 35 call
C. Long Mar 30 call, Short Mar 20 call
D. Long Mar 30 call, Short Apr 30 call

Answer 21

B. Long Mar 30 call, Short Mar 35 call

Rationale:
A 30 call is worth more than a 35 call, so if he bought the 30 call, he starts with a debit. Had he sold that more valuable option, he would have had a credit spread.

Question 22

Put the following steps in order from first to last.

I. Signed options agreement returned
II. Determine suitability
III. First trade may occur
IV. Options principal approves the account

A. I, III, II, IV
B. II, I, IV, III
C. II, IV, III, I
D. I, II, IV, III

Answer 22

C. II, IV, III, I

Rationale:
Remember that the first step is to determine suitability—the last thing that has to happen is for the customer to return the signed options agreement.

Question 23

If ARZ undergoes a 5:4 split, how will the following contract be adjusted?
Long ARZ Mar 50 call

A. Long (120 shares) ARZ Mar 45 call
B. Long 2 ARZ Mar 40 calls
C. Long (125 shares) ARZ Mar 40 call
D. Long 2 ARZ Mar 25 calls

Answer 23

C. Long (125 shares) ARZ Mar 40 call

Rationale:
To answer this question just treat it like a regular old stock split question. Long 100 shares @50 would become Long 125 shares @40.

Question 24

An active trader is short 200 shares ZRZ @70 and long 2 ZRZ Mar 75 calls @3. When ZRZ trades @ 65, he covers his short position and closes the tions for their intrinsic value, ending up with:

A. A loss of $500
B. A gain of $400
C. A gain of $600
D. A loss of $1,000

Answer 24

B. A gain of $400

Rationale:
Makes $1,000 on the stock and loses the call premiums, right? The option was not exercised.

Question 25

An investor owns 100 shares XYZ @50, holds an XYZ Mar 50 call @3 and sold short 1 XYZ Mar 45 put @2. When XYZ trades @52.75, she sells her stock and closes both contracts for their intrinsic value, ending up with:

A. A gain of $650
B. A gain of $450
C. A loss of $100
D. A loss of $250

Answer 25

B. A gain of $450

Rationale:
This looks hard, but the question gives you four of the six numbers you need in your T- chart. You have the stock price paid and received. Put the price paid in the debit column and the price received in the credit column. Put the “3” for the call in the debit column, since that was the price paid. What’s the call worth when the stock is at $52.75? $275. Put that in the credit column, since that’s what he’d sell it for now. The puts expire worthless, allowing him to keep the $200 with a big goose egg in the debit column. Now, just tally it up. You have a “50.” a “3” and a “0” in your debit column. 53. You have “52.75” a “2.75” and a “2” in the credit column. $57.50. 53 out of 57.50 in – A gain of $450.

Question 26

An importer owns 10 Canadian dollar (50,000) 75 calls @ .80.
What is the total exercise price for the underlying currency?

A. 40,000 Canadian dollars
B. $375,000.00
C. $40,000.00
D. $37,500.00

Answer 26

B. $375,000.00

Rationale:
The “75M strike price means 75 cents. The contract allows the holder to buy 50,000 Canadian dollars for 75 cents each. That’s a total of $37,500. And there are 10 contracts, eh? You noticed that, eh?

Question 27

Given a position limit of 10,500, if Luann Long is long 10,000 calls, she may purchase how many puts?

A. Any number
B. 10,500
C. 10,000
D. 500

Answer 27

B. 10,500

Rationale:
Long puts are on the other side of the market, so she can have 10,500.

Question 28

All of the following would be considered “acting in concert” except:

A. Husband and wife
B. Registered rep with discretion over 15 accounts
C. Registered rep with discretion over 5 accounts
D. 10 traders purchasing puts within the same three-hour period

Answer 28

D. 10 traders purchasing puts within the same three-hour period

Rationale:
That’s a coincidence, not acting in concert. Husbands
and wives are presumed to be on speaking terms and acting together, and a rep who controls a bunch of accounts is acting in concert.

Question 29

If Joe is short 17 ART Apr 55 puts @3.55, he must close by
doing what and by what time?

I. Exercise the puts
ll. Buy the puts
III. By 11:59 EST Saturday
IV. By 4:02 EST Friday

A. II, IV
B. I, III
C. I, IV
D. II, Ill

Answer 29

A. II, IV

Rationale:
To close you just do the opposite. He wrote puts, so he buys them back by the deadline of 4:02 Eastern.

Question 30

Carla is concerned about falling interest rates. For best protection she should:

A. Sell yield-based puts
B. Buy yield-based puts
C. Sell price-based calls
D. Buy price-based puts

Answer 30

B. Buy yield-based puts

Rationale:
To protect you have to buy something. If rates are falling, yields are falling. Price goes the other way. So, if you buy a put on the price, you’ll lose. Rates down, price UP.

Question 31

Maria is worried that interest rates are about to rise sharply. In order to protect against the spike in rates, she should:

A. Sell yield-based puts
B. Sell price-based calls
C. Buy price-based calls
D. Buy yield-based calls

Answer 31

D. Buy yield-based calls

Rationale:
To protect you have to buy. Rates up, price down. Buy puts on the price, not the yield. Yields would go up with the rates-if anything, you’d buy a call on the yield.

Question 32

Jens Jensen wrote a QRZ May 55 put @3.75. When QRZ dropped to $49.55, Jens received an assignment notice. If he immediately sells the stock acquired at the market price, what are the tax implications?

I. Cost base of $49.55 per share
II. Cost base of $51.25 per share
III. Proceeds of $53.30 per share
IV. Proceeds of $49.55 per share

A. II, III
B. I, III
C. II, IV
D. I, IV

Answer 32

C. II, IV

Rationale:
He is obligated to pay $55 per share for the stock, but that’s only because he took IN the premium, which reduces the amount he spent. His proceeds would be what he sold the stock for.

Question 33

Berry Baird is short an XYZ Sep 75 call @2.25. If the call is exercised with XYZ @75.50 what is Berry’s cost base in XYZ?

A. $74.25 per share
B. $77.25 per share
C. $75.50 per share
D. $75.00 per share

Answer 33

C. $75.50 per share

Rationale:
For these cost base/proceeds questions ask yourself what the option led to. If it led to a purchase, the premium affects cost base. If it led to a sale, it effects proceeds. This option led to a sale, so the premium only affects the proceeds. The cost base is simply what he paid for the stock. The proceeds would be $77.25.

Question 34

Bonnie Baird is short an XYZ Sep 75 call @2.25. If the call is exercised with XYZ @75.50 what is the amount of Bonnie’s
proceeds for XYZ?

A. $74.25 per share
B. $75.50 per share
C. $75.00 per share
D. $77.25 per share

Answer 34

D. $77.25 per share

Rationale:
Ask yourself what the option led to. If it led to a purchase, the premium affects cost base. If it led to a sale, it affects proceeds. This option led to a sale, so the premium is added to the proceeds. Sold the stock
for $75 and also took in the premium for total proceeds of $77.25 per share.

Question 35

Which of the following statements is correct?

A. A call is in the money when the underlying security trades above the strike price
B. A call is in the money when the strike price is less than the market price
C. A put is in the money when the strike price is above the market price
D. All choices listed

Answer 35

D. All choices listed

Rationale:
They’re all true statements.

Question 36

An IBM Mar 70 put @5.15 has how much intrinsic value with IBM trading at 69?

A. $5.15
B. $0
C. $1
D. $4.15

Answer 36

C. $1

Rationale:
Just go to the strike price of 70 and see if you can “put down” to the market price. You can, so the put is in the money. You can put down by $1 from 70 to 69, so it’s in the money by $1. It has intrinsic value of $1.

Question 37

With ZTY @57.25, which of the following is in-the-money?

A. ZTY May 55 put
B. ZTY May 60 put
C. ZTY May 60 call
D. ZTY May 50 put

Answer 37

B. ZTY May 60 put

Rationale:
If the stock trades above the call’s strike price–or below the put’s strike price-the option is in-the-money. With the stock at $57.25, the right to sell it at 60 represents a contract that is in- the-money (has intrinsic value).

Question 38

Your customer is convinced that the overall market is headed for a correction. To increase yield and receive partial protection, she should:

A. Buy broad-based index puts
B. Buy narrow-based index calls
C. Sell broad-based index puts
D. Sell broad-based index calls

Answer 38

D. Sell broad-based index calls

Rationale:
To increase yield or take in income, you have to sell something. Which way is the market heading? Down. Sell calls, not puts when something is going down.

Question 39

Your investor buys an XYZ Jan 45 call @2 and an XYZ Jan 40 put @1.50. With XYZ @38, she closes both positions for intrinsic value for a:

A. A gain of $350
B. A gain of $150
C. Loss of $150
D. Loss of $350

Answer 39

C. Loss of $150

Rationale:
Loses the call premium, so there’s a loss of $200. Only makes $50 on the put.

Question 40

Which of the following is considered a “combination”?

A. Long IBM May 70 put, short IBM Jun 80 put
B. Long MSFT Mar 50 call, short MSFT Mar 60 call
C. Long MSFT Mar 50 call, long MSFT Mar 45 put
D. Short IBM May 70 put, short IBM May 70 call

Answer 40

C. Long MSFT Mar 50 call, long MSFT Mar 45 put

Rationale:
If it’s almost but not quite a straddle or spread, it’s a combination.

Question 41

How many days does the customer have to return the signed OCC Disclosure Document?

A. 5 business days
B. 5 days
C. 15 business days
D. None of the choices listed

Answer 41

D. None of the choices listed

Rationale:
A trick question—nobody signs the OCC Disclosure Document. That’s the prospectus that should be read
before trading in options. It’s the options agreement that must be signed within 15 days. If not, the investor can only close existing positions—no new ones could be established. You can get this OCC Disclosure Document as a PDF, I believe, at www.cboe.com.

Question 42

Your client bought an IBM May 75 put @2.25. IBM closes @74, but your customer has forgotten that today is expiration Friday. What would happen in this instance at expiration?

A. Customer must deliver 100 shares IBM within 3 business day
B. Customer pays a fine of not more than $2,500
C. The option is exercised automatically
D. Customer pays a fine of not more than $250

Answer 42

C. The option is exercised automatically

Rationale:
If it’s in the money by 5 cents or more, the option is
automatically exercised. So you have to pay attention on expiration day. Not that you can lollygag on the other days.

Question 43

Rebecca owns 15 ARZ Apr 55 calls @3. How many shares of ARZ does she control between now and the third Friday of
April?

A. 15
B. 1500
C. None
D. 300

Answer 43

B. 1500

Rationale:
If you missed it, you’re getting tired. It said she owns 15 options then asked you how many options she owned.

Question 44

An investor believes that the price of RTZ is about to rise. All of the following strategies would be appropriate except:

A. Debit call spread
B. Short put
C. Long call
D. Short call

Answer 44

D. Short call

Rationale:
Short calls are bearish. Bulls anticipate things are going to rise.

Question 45

Options are defined as:

A. Present value proxies
B. Futures
C. Derivative
D. Speculative

Answer 45

C. Derivative

Rationale:
They derive their value from something else, so options are called derivatives.

Question 46

As the price of a stock falls the premiums of puts on that stock generally:

A. Flatten
B. Rise
C. Fall
D. Elongate

Answer 46

B. Rise

Rationale:
A put is the “right to sell stock at the strike price.” So the farther the stock falls below the strike price, the more valuable the put options becomes. Or, if the puts are not quite in the money, they still become more valuable as the stock price falls closer and closer to the strike price, making it more likely that they will end up in the money.

Question 47

All of XYZ’s calls would be considered a:

A. Series
B. Call log
C. Class
D. Round lot

Answer 47

C. Class

Rationale:
Memorize it.

Question 48

All MSFT May 55 puts make up a:

A. None of the choices listed
B. Series
C. Class
D. Set

Answer 48

B. Series

Rationale:
That’s a series. I buy that series in Cleveland; you sell that series in Tampa Bay. If I exercise the call, it could end up in your lap. Buyers exercise the contract—sellers are assigned the contract.

Question 49

For writers of puts, all of the following would usually result in
gain except:

A. Price of the stock falls by a smaller dollar amount than the difference between the strike price and the premium collected
B. Price of the stock rises above the strike price and remains there or higher through expiration
C. The option expires worthless
D. Price of the stock falls by a larger dollar amount than the difference between the strike price and the premium collected

Answer 49

D. Price of the stock falls by a larger dollar amount than the difference between the strike price and the premium collected

Rationale:
A seller has a breakeven point. As long as the stock doesn’t go beyond the breakeven point, the seller wins. If the option expires worthless, that’s as good as it gets. It’s like a White Sox fan watching the Cubs self-destruct in the 9th inning.

Question 50

Who issues listed options?

A. Buyers of options
B. OCC
C. Sellers of options
D. CBOE

Answer 50

B. OCC

Rationale:
A point to memorize.

Question 51

Janice Jennings writes 10 XRT 55 puts @3.50 with XRT @54.
Her maximum gain is:

A. $250
B. $350
C. $3,500
D. Unlimited

Answer 51

C. $3,500

Rationale:
She can only make what she takes in, $3,500.

Question 52

Which of the following are considered advantages of buying puts as opposed to selling stock short?

I. The risk of buying puts is less
II. Puts do not experience erosion of time value
III. Puts are bearish

A. I, II, III
B. I, II
C. I
D. III

Answer 52

C. I

Rationale:
You can only lose what you pay for the put, so that’s better than being able to lose everything you ever owned and then some on an ill-timed short sale. Both short stock and long puts are bearish, so eliminate that answer choice. And don’t believe the false statement that puts don’t lose value as time goes on. All options lose time value as time evaporates. You’d pay someone more for a put that gave you three weeks to win than for a put that gave you three days, right?

Question 53

If your customer sells 15 puts, she has the right to:

Answer 53

Rationale:

Sellers don’t have rights. Buyers have rights; sellers have obligations.

Question 54

The only position below that does NOT subject the investor to unlimited risk is:

A. Selling stock and then selling a put on that stock
B. Naked call writing
C. Selling straddles
D. Writing uncovered puts

Answer 54

D. Writing uncovered puts

Rationale:
Writing puts presents a limited risk. A stock can only go to zero, so if you write a Jun 50 put, you could lose $50 if the stock drops to zero, minus whatever you took in for selling the thing.

Question 55

With XRZ trading @43 and the XRZ Oct 45 puts trading @3, which of the following is a true statement?

A. The options are in-the-money
B. The options are at the break-even
C. The options have no intrinsic value
D. The options have no time value

Answer 55

A. The options are in-the-money

Rationale:
The options have $1 of time value. They cost $3 when they only have intrinsic value of $2. The next statement is false because the puts are clearly in the money. The breakeven point is just “strike price minus premium” or $42—the stock is only at $43.

Question 56

What is true of options investors’ capital gains and losses?

I.Ordinary options buyers’ gains and losses are short-term
II.Ordinary options writers’ gains and losses are treated as long- term
III. LEAPS® writers’ gains at expiration are treated as long- term
IV. IV. LEAPS® writers’ gains at expiration are treated as short- term

A. I, II
B. II, III
C. I, III
D. I, IV

Answer 56

D. I, IV

Rationale:
Just the IRS trying to keep everything nice and simple.

Question 57

If an investor believes that a stock’s price will remain unchanged over the next few months, you would least likely recommend a:

A. Credit call spread
B. Long straddle
C. Long put
D. Short straddle

Answer 57

B. Long straddle

Rationale:
You go long a straddle for the opposite reason-you think the market will move big time in one direction or the other. If you think the market is going to sit still, you sell, not buy, a straddle.

Question 58

Given a position limit of 10,500, if an investor is long 10,000 calls, he may buy:

A. 10,500 puts
B. 500 puts
C. Unlimited
D. No more puts

Answer 58

A. 10,500 puts

Rationale:
Long puts are on the other side of the market from long calls, so you can have 10,500 of each given this position limit. This investor could only sell 500 puts given his 10,000 bull positions.

Question 59

What is the maximum loss to a writer of a naked call?

A. Strike price minus premium
B. Unlimited
C. Strike price plus premium
D. Unlimited times infinity

Answer 59

B. Unlimited

Rationale:
The call writer never knows how much he’ll have to pay to buy the stock, which is why I’ve never been a naked call writer. I don’t like to risk my house for a few hundred or thousand bucks. But that’s just me.

Question 60

The maximum gain to a put writer is:

A. Unlimited
B. Premium
C. Strike price plus premium
D. Strike price minus premium

Answer 60

B. Premium

Rationale:
The maximum gain to a writer/seller/short guy is the premium, whether he’s writing calls or puts, straddles or spreads. You can never take in more than you took in writing the option(s).

Question 61

Upon exercise which of the following will buy stock?

I. Long put
II. Short put
III. Long call
IV. Short call

A. I, IV
B. II, III, IV
C. I
D. II, III

Answer 61

D. II, III

Rationale:
Bulls buy; bears sell. You’re interested in buying something because you think it will be worth more. You’re interested in selling something because you think it will be worth less, or even worthless.

Question 62

Unlike a short seller of stock, the purchaser of a put:

I. Is bearish
II. Is bullish
III. Has less risk

A. II
B. I, III
C. I
D. III

Answer 62

D. III

Rationale:
A short seller can lose everything in the world, while a put buyer can only lose the premium paid. But they’re both bearish positions.

Question 63

If a customer writes an in-the- money put, her maximum gain
is:

A. Strike price minus premium
B. Unlimited
C. Premium
D. Strike price plus premium

Answer 63

C. Premium

Rationale:
Writers make the premium, end of story. Why did we insert the “in-the-money” part? Just the sort of jerks we have to be to prepare you for a bunch of even bigger jerks who write misleading test questions for a living.

Question 64

An investor is short an RRR Nov 75 put @ 3.75 with RRR trading @73. Therefore:

A. The put has no time value
B. The put is out of the money
C. The investor is in the money
D. The put has intrinsic value

Answer 64

D. The put has intrinsic value

Rationale:
The put is clearly in the money. Whenever the stock is below the strike price, the put is in the money. It has intrinsic value, in other words. The intrinsic value is only $2, so the rest of the premium ($1.75) is the time value.

Question 65

An investor who owns a put will profit upon exercise of the contract if:

A. The stock trades at strike price less premium
B. The stock trades above the strike price minus the premium
C. The stock trades below the breakeven
D. The stock trades below the strike price

Answer 65

C. The stock trades below the break-even

Rationale:
For a buyer to profit, the stock has to go below the break-even point, right? Until you get to the break-even point, you’re out some money. When it gets to the breakeven point you are, well, even. Only beyond that point do you make money.

Question 66

Upon assignment a call writer will profit if:

A. The stock’s market price equals strike price plus premium
B. The stock’s market price is less than the strike price plus the premium
C. The stock’s market price exceeds the strike price by more than the premium
D. The stock trades above the strike price

Answer 66

B. The stock’s market price is less than the strike price plus the premium

Rationale:
The seller has a breakeven point. As long as the stock never makes it to the breakeven point, he wins. The break-even point for the call is strike price+premium.

Question 67

If an option is at-the-money, its time value is:

A. strike price minus premium
B. 75% of the premium
C. Zero
D. 100% of the premium

Answer 67

D. 100% of the premium

Rationale:
If it’s not in the money the premium is pure time value.

Question 68

In order to close a short put position, an investor would:

A. Buy stock
B. Short an unequal number of shares of the underlying
C. Enter a closing purchase
D. Enter a closing sale

Answer 68

C. Enter a closing purchase

Rationale:
If you do an opening sale, you make a closing purchase.

Question 69

An investor writes a WYZ Mar 75 put @2.25 with WYZ @73. If WYZ trades at 76 at expiration, the investor will:

A. Gain $225 
B. Lose $125 
C. Lose $75
D. Gain $12
5

Answer 69

A. Gain $225

Rationale:
If the put expires, the seller keeps the premium. Not that they would ever give back the premium. By “keep the premium” we mean he makes more than he has to spend later. Anyway, puts always expire when the stock is at or above the strike price on expiration day.

Question 70

As the result of a 25% stock dividend an MSFT May 50 call
would become:

A. MSFT (125shares) Jun 40 call
B. MSFT (125 shares) May 40 put
C. 2 MSFT May 25 calls
D. MSFT (125 shares) May 40 call

Answer 70

D. MSFT (125 shares) May 40 call

Rationale:
If you were long 100 shares @50, you’d be long 125 shares @40 after a 25% stock dividend. Still has to have the same expiration month, though. And calls don’t become puts all of a sudden, no matter how sick and tired you are of both.

Question 71

Jason is considering writing options to generate income. Looking at the October puts on XYZ common stock, Jason
would find which of the following strike prices to be associated with the highest premium?

A. 80
B. 85
C. 70
D. 75

Answer 71

B. 85

Rationale:
“Put” means “right to SELL” We want to sell HIGH.

Question 72

Jason is considering writing call options. Looking at the November ABC calls, he would find which of the following strike
prices associated with the highest premium?

A. 85
B. 70
C. 75
D. 80

Answer 72

B. 70

Rationale:
“Call” means “right to BUY.” We want to buy LOW.

Question 73

What is true of options in connection with margin accounts?

A. Options may be purchased within margin accounts if the buyer pays the premium in full
B. Options may be purchased on margin by meeting the 75% Reg T requirement
C. Only short options may be initiated within a margin account
D. Options may not be purchased within margin accounts

Answer 73

A. Options may be purchased within margin accounts if the buyer pays the premium in full

Rationale:
Just something else to memorize. When studying margin accounts, remember that many things that can’t be bought “on margin” are still bought in a margin account. A margin account is simply an account approved for margin—you can buy most stocks and bonds by putting down only half the purchase price, but some things have to be bought and paid for in full (options, IPO’s, mutual funds).

Question 74

Which of the following is the name used for an options position in which the investor is both long and short a different series of the same “class”?

A. Short straddle
B. Long straddle
C. Married put
D. Spread

Answer 74

D. Spread

Rationale:
If you buy and sell calls or puts of different “series” (Oct 40, Oct 45, etc.), you establish a spread.

Question 75

A _______ is established when a customer purchases a call and a put on the same underlying instrument wherein the options are of the same strike price and expiration.

A. Covered call
B. Long straddle
C. Short spread
D. Short straddle

Answer 75

B. Long straddle

Rationale:
If you buy a call and a put with the same terms, you establish a long straddle.

Question 76

To establish a long options position, an investor must meet the initial margin requirement of:

A. 100%
B. 30%
C. 50%
D. 25%

Answer 76

A. 100%

Rationale:
Options are paid in-full

Question 77

Concerning the trading of standardized options, many terms are used synonymously. All of the following pairs of terms are synonymous except:

A. Intrinsic value, in-the-money
B. Time value, out-of-the-money
C. Short, write
D. Holder, owner

Answer 77

B. Time value, out-of-the-money

Rationale:
An option can have time value whether it’s in, at, or out-of- the-money. It only has intrinsic value when it’s in-the-money.

Question 78

As a registered representative you have determined that one of your customers should write uncovered options. This recommendation would be suitable:

A. Under no circumstances
B. Only after gaining principal approval to present the recommendation
C. If the investor met the SEC definition of “accredited investor*
D. If you determined that the customer was aware of the risks involved and had the capacity to assume the risks

Answer 78

D. If you determined that the customer was aware of the risks involved and had the capacity to assume the risks

Rationale:
Some people can handle the potentially massive losses involved with writing uncovered options (i.e. naked calls). But if you’re going to RECOMMEND such foolishness, you’d better be sure the customer understands what he’s getting into and can laugh off a few huge losses.

Question 79

Settlement between a clearing member firm and the Options Clearing Corporation occurs:

A. T+2
B. Same day
C. T+3
D. Next business day following the trade date

Answer 79

D. Next business day following the trade date

Rationale:
Options settle T + 1. The OCC guarantees performance of the contract, even if the other
member firm defaults. At which point the OCC takes the firm out back and, you know, shoots somebody.

Question 80

Which of the following would NOT lead to an adjustment of
strike prices on ABC’s call and put options?

A. Stock dividend declared by ABC’s
B. Cash dividend declared by ABC’s board of director
C. Forward stock split approved by ABC shareholders
D. Reverse stock split approved by ABC shareholders

Answer 80

Cash dividend declared by ABC’s board of directors

Rationale:
Stock dividends and stock splits change the share price of the stock, so all strike prices have to be adjusted (as do the prices on convertible bonds, convertible preferred, warrants, etc.). A cash dividend does not affect the strike price of an option.

Question 81

One of your investing customers is currently short one ABC Aug 45 put. To liquidate this position, you would enter which of the following?

A. Closing sale
B. Opening sale
C. Opening purchase
D. Closing purchase

Answer 81

D. Closing purchase

Rationale:
If you sold an option, you close it out by buying it back. Buy to close/closing purchase.

Question 82

Jimmy Rogers bought 300 shares XYZ @44 and wrote 2 XYZ Oct 45 calls @2. As his registered rep, you should mark the options order ticket:

A. Opening sale, uncovered
B. Opening sale, covered
C. Opening purchase, covered
D. Short sale

Answer 82

B. Opening sale, covered

Rationale:
It’s an opening sale of the call, and the call is covered.

Question 83

The ABC Aug 25 puts expire on:

A. September 1
B. August 25th
C. Saturday, August 26th
D. Saturday following the third Friday of August

Answer 83

D. Saturday following the third Friday of August

Rationale:
The “25” is the strike price. If not, why would there be strike prices of “40” or “150”?