Dummies Series 7 > Chapter 12: Options > Flashcards
Chapter 12: Options Flashcards
Opening purchase
When an investor 1st buys call or put
Opening sale
When an investor 1st sells call or put
Closing purchase
When an investor buys self out of previous option that he had sold
Closing sale
When an investor sells out of a previous option position that he had purchased
Straddle
Long Call
Long Put
or
Short Call
Short Put
Same security, strike price, and expiration
Sell 1 IBM Jan 10 Call 5
Sell 1 IBM Jan 10 Put 1
Short straddle
Buy 1 IBM Jan 10 Call 5
Buy 1 IBM Jan 10 Put 1
Long straddle
Sell 1 IBM Jan 10 Call 5
Sell 1 IBM Jan 5 Put 1
Short combination
Spread (options)
Long Call
Short Call
or
Long Put
Short PutBuy 1 IBM Jan 10 Call 5
Sell 1 IBM Jan 10 Call 1
Long (Bull) Call Spread
Buy 1 IBM Jan 5 Put 1
Sell 1 IBM Jan 10 Put 5
Short (Bear) Put spread
Buy 1 IBM Jan 10 Call 5
Buy 1 IBM Jan 5 Put 1
Long combination
Covered call
Selling a call option on a stock already owned
Call holder
- Right to buy
- Bullish
Call seller
- Obligation to sell
- Bearish
Put holder
- Right to sell
- Bearish)
Put seller
- Obligation to buy
- Bullish
Call Holder:
Max Gain/Loss
- Max gain = unlimited
- Max loss = premium
Call seller:
Max Gain/Loss
- Max gain = Premium
- Max loss = unlimited
Put holder:
Max Gain/Loss
- Max gain = strike - premium
- Max loss = premium
Put seller:
Max Gain/Loss
- Max gain = premium
- Max loss = strike - premium
Call option breakeven point
Strike price + premium
Put option breakeven point
Strike price - premium
Call option breakeven point
Strike price + premium
Put option breakeven point
Strike price - premium
Call option breakeven point
Strike price + premium
Put option breakeven point
Strike price - premium
A call option is in the money when
- The price of the stock is above the strike price
- CALL UP
A put option is in the money when …
- When the price of the stock is below the strike price
- PUT DOWN
Intrinsic value
The amount an option is in the money
Option premium formula
Premium = Intrinsic value + time value
“Calls same”
Premium and strike price go on same side of the chart
“Puts switch”
Premium and strike price go in opposite sides of the options chart
A call option is in the money when …
- The price of the stock is above the strike price
- “CALL UP”
A put option is in the money when …
- When the price of the stock is below the strike price
- “PUT DOWN”
Intrinsic value
Amount option is in the money
Calculate the time value of an option
Premium = Intrinsic Value + Time Value
Break-even point for a Call
- “Call Up”
- Strike price + Premium
Break-even point for a Put
- “Put Down”
- Strike price - Premium
Stock dividends for an options contract
- Number of option contracts remain the same
- Strike price decreases
- Number of shares per option contract increases
Capped index options
- Have a limited max gain or loss because the option will be capped at 30 points in the money
- Max gain or loss is $3,000
Because of the additional risk involved when investing in options all investors must receive an _________ prior to the first transaction
ODD (Options disclosure document)
Which of the following transactions may be executed in a cash account?
I. the purchase of a call option
II. the sale of a covered call option
III. the short sale of a stock
IV. the sale of a naked option
A. I only
B. I and II
C. I and III
D. III and IV
B. I and II
The purchase of call options and the sale of covered call options may be executed in cash accounts. Because of the additional risk, short sales, the sale of naked options, and spreads must be executed in margin accounts.
Your client writes a naked put option on ABC common stock. What is the maximum loss per share that the client can incur?
A. strike price minus the premium
B. strike price plus the premium
C. the entire premium received
D unlimited
A. strike price minus the premium
When writing (selling) a naked (uncovered) call option, the maximum loss is unlimited. However, when writing a naked put option, the maximum loss is the strike (exercise) price minus the premium. Put options go in the money when the price of the stock drops below the strike price. This means that a put option can go only so far in the money because the price of the underlying stock can only drop to zero. Therefore, the maximum loss per share is the strike price less whatever the client received per share when he sold the option.
Bullish option strategies include
I. buying calls
II. buying puts
III. writing in the money calls
IV. writing in the money puts
A. I and III
B. I and IV
C. II and III
D. II and IV
B. I and IV
Buying calls is a bullish strategy because the investor wants the price of the underlying security to increase. In addition, selling in the money put options is also bullish because the seller wants the price of the underlying security to increase. When selling a naked option, the most an investor can hope to make is the premium received, therefore the seller wouldn’t want the put option to go into the money more; he’d want the underlying stock to increase in value
Which option is out of the money if ABC is at $40?
A. ABC May 45 put
B. ABC May 35 call
C. ABC May 50 call
D. ABC May 55 put
C. ABC May 50 call
The phrase “call up and put down” will help you remember that call options go in the money when the price of the stock goes above the strike price, and put options go in the money when the price of the stock goes below the strike price.
A. is in the money because the price of the stock is below the put price of 45.
B. is in the money because the price of the stock is above the 35 call strike price.
D. is in the money because the price of the stock is below the 55 put strike price.
However, C is out of the money because the price of the stock is below the 50 call strike price.
An ABC Dec 50 call is trading for 9 when ABC is at $55. What is the time value of this option?
A. 0
B. 4
C. 5
D. 9
B. 4
P = I + T 9 = 5 + T T = 4
An investor would face an unlimited maximum loss potential if
I. writing 3 ABC Dec 25 puts
II. shorting 200 shares of ABC
III. writing 4 ABC Dec 30 naked calls
IV. writing 2 ABC Dec 30 covered calls
A. I and II
B. I and III
C. II and III
D. II and IV
C. II and III
You have to remember that sellers (writers or shorters) of options always face more risk than the buyers. The buyers’ risk is limited to the amount of money they invest. However, sellers of put options don’t face a maximum loss potential that is unlimited because put options go in the money when the price of the stock drops below the strike price, and it can only go down to zero.
An investor who is long a call option realizes a profit if exercising the option when the underlying stock price is
A. above the exercise price plus the premium paid
B. below the exercise price
C. below the exercise price minus the premium paid
D. above the exercise price
A. above the exercise price plus the premium paid
In order for an investor to profit from a long call position, he’d have to exercise the option when the market price is above the exercise (strike) price plus the premium paid.
When selling an uncovered put, an investor would realize a profit in all of the following situations EXCEPT
A. the price of the underlying stock increases in value above the strike price of the option
B. the premium of the put option decreases
C. the option expires exercised
D. the option is exercised when the price of the underlying stock is below the strike price minus the premium
D. the option is exercised when the price of the underlying stock is below the strike price minus the premium
When selling an uncovered put option, an investor takes a bullish position. The maximum potential gain is the premium received. In other words, the investor doesn’t want this option to be exercised because he’ll start losing money and possibly even end up taking a loss. Therefore, D is the correct answer.
Which of the following option contracts are in the money when ABC is trading at $43.50?
I. short ABC 35 call
II. short ABC 40 put
III. long ABC 40 call
IV. long ABC 50 put
A. I, III, and IV
B. II and IV
C. III and IV
D. I, II, and III
A. I, III, and IV
Call options go in the money when the market price is greater than the strike (exercise) price. Put options go in the money when the market price is lower than the strike price.
If holding which of the following positions would an investor deliver the stock if exercised?
A. long a call or short a call
B. long a call or short a put
C. long a put or short a call
D. long a put or short a put
C. long a put or short a call
Investors who are long a put or short a call deliver a stock when the option is exercised.
Long a call is the right to buy the stock.
Long a put is the right to sell the stock.
Short a call is the obligation to sell the stock.
Short a put is the obligation to buy the stock.
One of your clients is convinced that ABC common stock will decline in value over the next few months. Which investment strategy would you recommend to your client that would allow him to take advantage of the expected decline with the smallest cash investment?
A. buying an ABC call option
B. buying an ABC put option
C. shorting ABC stock
D. buying an ABC straddle
B. buying an ABC put option
You should have knocked out A right away because buying a call option is a bullish strategy. C and D would work but they aren’t the cheapest options. Buying a straddle is ideal when you aren’t sure which direction the stock is going because you’re buying a put and buying a call. When shorting a stock, an investor has to come up with 50% of the market value. Buying a put is the best answer because it’s a bearish strategy, and investors can have an interest in a large amount of securities for a small outlay of money.
If an investor sells a covered call on stock owned in an account, which of the following is TRUE?
A. the premium increases the cost basis
B. the premium decreases the cost basis
C. the investor has unlimited risk
D. the trade must be executed in a margin account
B. the premium decreases the cost basis
Selling covered calls reduces the cost basis (the amount he stands to lose). The best way to see this is to use sample numbers. Say that an investor purchased stock for $50 per share and then sold a covered call for $3. He originally spend $50 per share and then got $3 back, so his cost basis was reduced from $50 to $47 ($50-$3).
Options of the same series have the same
I. stock
II. expiration date
III. strike price
IV. type
A. I only
B. I and III
C. I, II, and III
D. I, II, III, and IV
D. I, II, III, and IV
Type means calls or puts.
The break-even point for an investor who is short a put is
A. the market price minus the premium
B. the market price plus the premium
C. the strike price minus the premium
D. the strike price plus the premium
C. the strike price minus the premium
The best way to determine the break-even point for an investor who has only an option position is to remember “call up and put down.” Because this is a put option you need to put down by subtracting the premium from the strike price. This answer would apply whether the investor was long or short the put.
The profit on an option transaction will be taxed as
A. a capital gain
B. ordinary income
C. investment income
D. passive income
A. a capital gain
All option transactions will result in a capital gain, a capital loss, or a break-even position.
Unless otherwise stated, a stock option contract represents
A. 1 share of the underlying security
B. 10 shares of the underlying security
C. 100 shares of the underlying security
D. 1,000 shares of the underlying security
C. 100 shares of the underlying security
When can European style options be exercised?
A. any time
B. 1 business day prior to expiration
C. 3 business days prior to expiration
D. any time during the expiration month
B. 1 business day prior to expiration
Unlike American style options, which can be exercised at any time, European style options can be exercised 1 business day prior to expiration. Almost all options are American style but world currency options may be either.
A customer with no existing position writes 1 ABC July 60 put and 1 ABC July 60 call. The position established is a
A. short combination
B. long combination
C. long straddle
D. short straddle
D. short straddle
A straddle consists of a put and a call on the same stock with the same strike price and expiration
Which of the following would affect the premium of an option?
I. volatility of the underlying security
II. the amount of time until the option expires
III. the intrinsic value
A. I and II
B. II and III
C. I and III
D. I, II, and III
D. I, II, and III
Which of the following is the riskiest option strategy?
A. Buying calls
B. Buying puts
C. Selling uncovered calls
D. Selling uncovered puts
C. Selling uncovered calls
When purchasing an option, the most you can lose is the premium. Therefore option sellers always face more risk than option buyers. When selling uncovered call options the maximum loss potential is unlimited because call options go in the money when the price goes above the strike price. In theory the price of the stock can keep going up.
Which of the following would affect the premium of an option?
I. volatility of the underlying security
II. the amount of time until the option expires
III. the intrinsic value
A. I and II
B. II and III
C. I and III
D. I, II, and III
D. I, II, and III
Which of the following is the riskiest option strategy?
A. Buying calls
B. Buying puts
C. Selling uncovered calls
D. Selling uncovered puts
C. Selling uncovered calls
When purchasing an option, the most you can lose is the premium. Therefore option sellers always face more risk than option buyers. When selling uncovered call options the maximum loss potential is unlimited because call options go in the money when the price goes above the strike price. In theory the price of the stock can keep going up.
Standard option contracts are issues with an expiration of
A. 6 months
B. 9 months
C. 12 months
D. 39 months
B. 9 months
LEAPS have expiration of up to 39 months.
An investor sells 1 ABC Jun 40 put at 6. What is the breakeven point?
A. 34
B. 40
C. 46
D. cannot be determined
A. 34
The easiest way to determine the breakeven point for an individual option is to remember call up and put down.
Call up: add the premium to the call strike price.
Put down: subtract the premium from he strike price.
Here: you must put down, 40 - 6 = 34
An investor writes an ABC Dec call for 7. What is this investor’s maximum potential gain?
A. $700
B. $5,300
C. $6,700
D. unlimited
A. $700
This question should be easy. You can use an options chart but it’s probably not necessary. The question doesn’t mention anything about this investor having any other stock or option positions so you’re just dealing with an individual option. Because this investor sold the option the most he can hope to make is then premium received.
An investor writes 1 ABC Dec 40 put at 3.25. If the put option is exercised when ABC is trading at $37.50 and the investor immediately sells the stock in the market, what is her gain or loss excluding commissions?
OUT | IN
-4000 | 325
| 3750
-4000 | 4075
An option position in which the investor buys a call and a put or sells a call and a put on the same underlying security with the same strike (exercise) price and the same expiration month is called a ________
Straddle
A “long straddle” is simply 2 calls and a “short straddle” is simply 2 puts.
An option position in which the investor buys and sells either a call or a put on the same underlying security is called a ________
Spread
A “call spread” is simply buying and selling 2 calls.
A “put spread” is simply buying and selling 2 puts.
Buying and selling 2 calls in which the buy option has a higher premium than the sell option is called a _______
Long call spread. Also known as a debit call spread because on an option chart the investor is down money.
(short call spread is the opposite)
Which of the following option positions provides an investor with potential premium income while limiting the maximum loss potential?
A. debit spread
B. credit spread
C. long straddle or long combination
D. short straddle or short combination
B. credit (short) spread
If the investor is looking for potential premium income, he must have sold something, so you can rule out choice C. Because the maximum loss potential for a short straddle or short combination is unlimited and the investor wants to limit his loss, you can cross out choice D. The only answer that works is a credit spread. To create a credit (short) spread, the investor sells an option that will be in the money first and purchases that will go in the money later. If the option never goes in the money, the investor gets to keep the premium of the option sold. To limit the loss, the investor purchases an option that will go in the money later. This position provides potential premium income and limits the potential loss.
The maximum loss potential for a short straddle or a short combination is _________
Unlimited
The ________ is the issuer and guarantor of all listed options. It decides which options will trade and their strike prices. In addition, when an investor decides to exercise his option, it randomly decides which firm on the other end will be responsible for fulfilling the terms of the option
Options Clearing Corporation
The ________ provides last sale information and current option quotations provided by participating exchanges. It collects data from exchanges like AMEX, the Boston Stock Exchange, and the Philidelphia Stock exchange and disseminates the info it collects
Options Price Reporting Authority (OPRA)
Because of the extra risk of investing in options, all option order tickets must be signed by a ________, which is a manager with a Series 4 license.
Registered options principal (ROP)
