Chapter 4 Options 25-30 Questions Flashcards

Question

Covered call writing

Answer 1

Selling calls when holding a long stock position Reduced upside potential of investment because of the stock climbs, you will have to sell

Answer 2

Buys RST at 53, and a Put of RST 50 for 2 Max gain unlimited- 200 Max loss is 500 Break even would be 55

Answer 3

Buy 100 shares of RST at 53 Write a call at 55 for 2 Max gain is 400 Max loss is 5100 Limits upside while not protecting downside

Answer 4

Sells short 100 shares at 58 Buys call at 60 for 3 Max gain 5500 Max loss is 500 Breakeven is 55

Answer 5

Sells 100 shares at 55 Writes Put at 55 for 2.50 Max gain 250 Max loss is unlimited minus 250 Breakeven is 57.50

Answer 6

Buys 100 shares at 50 Buys a Put at 45 for 3 Sells a Call at 55 for 3 Max loss 500 Max gain 500 Eliminates major downside risk, but also kills upside

Answer 7

Selling more calls than your long position covers Buy 100 shares at 55 Sell a call at 60 for 3 Sell a call at 59 for 4 Max gain 1100 Max loss unlimited No effect between 59-60

Answer 8

Simultaneously buy one option and sale of another option of the same class Ex. Long call and a short call Must be a long and a short Cannot be two longs or two shorts

Answer 9

1. Price Spread (vertical spread)- different strike prices but same expiration date. Most common on series 7. 2. Time spread (calendar or horizontal spreads)- different expiration, same strike price 3. Diagonal Spread- differ in both time and price Categorized as a debit or credit spread: if the short position has the higher premium then it's a credit spread

Answer 10

Used to reduce cost of a long position, bullish Buy 55 call for 6 Sell 60 call for 3 Max gain 200 Max loss 300 Breakeven: To find its the net premium added to lower strike Investor profits if both exercise

Answer 11

Debit = Widen = exercise Credit = narrow = expire To find break even Call spreads= net premium + lower strike Put spreads= higher strike - net premium

Answer 12

Reduce risk of a short option, investor establishing is bearish BE is short position + net premium Profit when option expires

Answer 13

Reduce cost of long Put position Establishing a debit is bearish Want the options to be exercised

Answer 14

Reduce risk of short Put position Potential reward is reduced Establishing a credit is bulliss (want market to rise so neither is exercised

Answer 15

If you are the buyer of a call at the lower strike and higher premium, you are bullish If you are buyer of a Call with Higher strike price and lower premium, you are bear Buyer ofPut with higher strike, and lower premium Bull Buyer of Put with lower strike and higher premium, Bear Buying lower strike you are the bull, buying higher you are bear

Answer 16

Buy low bull Buy high bear

Answer 17

1. Widen or shrink- If you are a debit customer paying the higher premium you want it to widen. 2. Bull is lower strike price in both option spreads 3. High premium for Call is the bull Higher premium for Put is the bear Bull call debit Widen Bull Put credit shrink Bear call credit shrink Beat Put debit Widen

Answer 18

Composed of a Call and a Put, with the same strike price and expiration Would probably buy in a volatile market Sell in a non volatile Buying both or selling both

Answer 19

Expecting substantial volatility in stock price, but uncertain of which movement Max gain is always unlimited

Answer 20

Expect very little change in the market price Collect two premiums for selling Want the market price to stay within the breakeven points

Answer 21

Composed of a Call and a Put with different strike prices, expiration months or both Similar to straddle, easier to establish than long straddles Make money if stock trades outside of breakeven in a long combo

Answer 22

The underlying security is not a stock, so it has different contract size and delivery

Answer 23

Based on 3 different types of indexes: 1. Broad-based- entire market, include S&P 100 (OEX), 500 and the Major Market Index (XMI) 2. Narrow based index- Movement of market segments in a specific industry 3. Index with particular focus- example is the VIX which measures volatility (high reading is not bullish or bearish, measures fear of volatility)

Answer 24

Multiplier is still $100 Settle on next business day, broad based stop trading at 4:15, narrow at 4 Settled in cash rather than delivery of a security Settlement price is end of market trading on day of exercise, not the settlement date Expire on the third Friday of the expiration month As long as there is time value, customer will make more by closing the position Excercise Settlement value is based on closing index value on day exercise instructions are received

Answer 25

The risk that the market will decline Can eliminate by buying portfolio insurance in the form of an option To hedge a portfolio of 920,000, you would have to buy 20 Puts if strike is 460 460*20= 9,200 (

Answer 26

All weeklies are European exercise, meaning they are exercised on expiration date

Answer 27

Measure of volatility of a stock related to volatility of market in general 1.0 is a perfect match Ex. If a portfolio has a beta of 1.2, then you may have to buy more Puts when insuring your portfolio

Answer 28

Yield based on strike price Ex. A strike of 35 is 3.5% yield Based on T-bill, Tnote, t bonds If yield moves from 3.5 to 4.5%, the investor will make $1000 ($100 per point) All are European style options

Answer 29

Available for trading on US listed exchanges for Australian Dollar, British pound, Canadian dollar, Japanese yen, and the Euro Speculate or protect against inflation of currency Importers and exporters often use

Answer 30

Cash settled, no physical delivery Contract sizes are usually 10,000 except the Yen which is 1,000,000 Strike prices are commonly quoted in US cents Yen is quoted in 1/100th of a cent One point is $100 Example: Swiss Franc with premium of 1.5 cents. Premium= 150 Traded between 9:30-4pm on Philadelphia Nasdaq Expire third Friday Settle on next business day when purchasing and selling and executing Buy or sell options based on currency you are purchasing in Exporters usually buy in regards to foreign currency except if exporting to US, where they buy on own currency

Answer 31

OTC market for options is limited due to options not being standardized Listed stock options trade from 9:30-4pm (excluding broad based which trade till 4:15) Trades can be made until 4pm in options Option trades are settled on the next business day. Stock delivered as a result of exercise is settled regular way (three business days) Contracts in the Money by at least a penny are exercised automatically unless otherwise instructed. Instruction must be received by 5:30 pm on last trade day 250,000 contract max on the same side of market Sides: long call/short put (bull side) vs short call/long Put (bear side) Exercise limit of 250000 in 5 business day period

Answer 32

1. Designated Primary Market Maker- Floor trader responsible for maintaining a two-sided market for an option. All equity options have a DPM. (Also have a eDPM) 2. Market Makers- registered to trade for own account. 3. Floor Broker- Firms rep on the floor of an exchange. Execute on behalf of customers and firm. 4. Order Routing System- used to route customer orders directly to trading post

Answer 33

Determines when new options are put on market Designates strike and expiration month Assigns exercise notices on a random basis Broker/Dealer that receives exercise notice can assign based on first in/first out or a fair and reasonable method Requires the OCC Options Disclosure Document must be distributed to clients and that a customer return a signed Options agreement to customers within 15 days of opening an options account Options account must be approved by branch manager Can make trade after approval but may only close position if Options agreement is not signed in 15 days

Answer 34

Required to designate a registered Options principal (series 4) to look over customer accounts Must also approve any distributions to clients Past performance cannot be included in Option advertising but can be in sales literature

Answer 35

Not adjusted for cash dividends less than 12.50 per option contract Adjustments to share count is rounded down New option contracts are generated when an even stock split occurs (ending in 1 ex. 3:1) 2:1 split of 1 ALF 60 becomes 2 ALF 30 Uneven receives new option symbol 3:2 split of 1 ALF 60 becomes 1 ALF 40 with 150 shares

Answer 36

Must designate when filling out an order ticket whether the trade is opening or closing a position Must also designate whether a sale is covered or uncovered If protected by another position it's called

Answer 37

Number of contracts outstanding in an option Higher interest, more liquid Put Call ratio- measures current open interest in trading of Put vs call Calculated by dividing puts over calls... the higher the more bearish Can be used as a contrarian indicator if the ratio becomes too skewed towards bearish

Answer 38

Capping- entering sell orders in order to keep a stock from rising above calls one is short of Supporting- entering purchase orders to keep price above a put Pegging- trying to keep price steady Front Running- Taking an option position before entering a block order received

Answer 39

When the account is approved by the Registered Options principal or before

Answer 40

Buyer reports a capital loss equal to The premium on date of expiration! LEAPS writers will report a short term capital gain if it expires without being exercised regardless of whether it went over 12 months

Answer 41

Cap gain or loss equal to price differences on basis of how long it was held

Answer 42

Cost basis if you end up purchasing the stock will be increased or decreased by premium Ex. Exercise a long call, cost basis would be strike price plus premium paid Sale proceeds if you end up selling a stock will be increased or decreased by premium Ex. You sell a call and it's exercised. Your proceeds will be the strike price plus the premium you received Exercising an option does not necessarily constitute a taxable event

Answer 43

If a stock has been held for 11 months and the investor buys a Put to lock in a sale price, the investors return will be classified as a short term gain though the stock could be held for 20 months at time of exercise

Answer 44

If you buy a Put along with a stock on the same day, the cost basis of the stock is raised to include the Put.

Answer 45

Carries unlimited loss potential

Answer 46

Spread- 3types: Price, Time and Diagonal Have two of a class (Call or a Put) one bought, one sold Price- buy Call in May at 50, sell Call in May at 60 Time- buy Call in May at 50, sell Call in June and 50 Diagonal- buy Call in May at 45, sell Call in June at 50 Straddle- composed of a Call and a Put at the same price both bought Long- Buy call in may at 50, Buy Put in may at 50 Short- Sell call in may at 50, sell put in May at 50 Combination- Variation of a straddle either in date, or strike or both Ex- Sell call in may at 50, Sell put in may at 55

Answer 47

Purchases of options settle on the next day Broad based index options stop trading at 4:15pm Narrow based index options and stock options stop trading at 4pm

Answer 48

Settlement of an equity option is regular way (3 business days) for exercise Index options settle next business day for exercise Buying or selling option is next business day

Answer 49

Acts as an agent in maintaining the electronic order book on behalf of the CBOE and a market maker who may trade for his own account

Answer 50

Buy a Put Sell a Put Removes the risk

Answer 51

Must buy at the same strike or higher to cover a short Put

Answer 52

11:59 pm on the third Friday

Answer 53

Only referring to regular options unless specifying leaps

Answer 54

Assume unlimited loss potential in a rising market While have a limited maximum gain

Answer 55

Would mark the ticket with the net long position and the remaining shares would be short

Answer 56

Divide the credit balance by 1.3