Chapter 5: Options Contracts Flashcards
______ are legally binding contracts between buyers and sellers.
Options
The option holder has the ______ (______ option) or the ______ (______option) a(n) ______ (100 shares) of the underlying security at a specified price, known as the “______” or “______” price.
- Right to Buy (Call Option)
- Right to Sell (Put Option)
- Round Lot
- Strike
- Exercise
The buyer of an option is called the “______”.
Holder
______ are valid for a specified period of time; consequently, the ______ has a definite start and expiration date after which the ______ itself is worthless.
Option(s)
An option buyer (holder) pays a(n) ______ (option price) for the ______, but not the ______, to exercise the option within a specified time period.
- Premium
- Right
- Obligation
If the option holder chooses to exercise the option, then the ______ (seller) of the option contract is ______ to buy or sell the security at the strike price.
- Writer
2. Obligated
The ______ standardizes options contracts so they can trade on exchanges. It sets strike prices, expiration dates, contract sizes, and is the issuer and clearing agent for listed options. It is owned by the ______ that trade options.
- Options Clearing Corporation (OCC)
2. Exchanges
There are two types of options contracts: ______ and ______.
A(n) ______ of options consists of options of the same type on the same underlying security.
A(n) ______ of options consists of options of the same class that also have the same expiration date.
The exercise style of the option: ______ or ______.
The ______ is the price of an option.
The ______ or ______ price is the price at which an option can be exercised.
- Puts and Calls
- Class
- Series
- American or European
- Premium
- Strike or Exercise
The ______ has a long position in option, pays the premium (price), and has the right to exercise the option.
Option Holder
The ______ has a short position in the options, sells a put or call that they don’t own, collects the premium (price), and has the obligation to buy or sell the underlying security if it is exercised.
Option Writer
The ______ is the day on which the option contract ceases to exist or becomes worthless. At ______, options are either exercised or expire.
- Expiration Date
2. Expiration
Equity options expire on the ______ at ______. This is the last trading day, unless it is a holiday, in which case expiration and the last trading day will fall on the ______ of the expiration month.
- Third Friday of the Month
- 11:59 P.M. Eastern Time
- Third Thursday
______ are negotiated options that trade in the OTC market. They are not standardized or listed on an exchange. ______ are often used by portfolio managers to help them hedge or protect their portfolios, because these options can be custom-designed to meet the portfolio’s needs at a specific time.
- Over-The-Counter (OTC) Options
2. OTC Options
A(n) ______ is a contract that gives the call holder the right to purchase 100 shares of the underlying security, at the strike price (also called the exercise price), until expiration.
Call Option
A call holder does NOT receive ______ on the underlying security or have ______.
- Dividends
2. Voting Rights
The call holder has the ______, but is not ______, to exercise the option within a specified period of time. A call holder pays the ______ for the call.
- Right
- Obligated
- Premium
A call writer sells the call ______. He has the ______ to sell 100 shares of the underlying security at the ______ price, until expiration. The call writer receives the ______.
- Short
- Obligation
- Strike
- Premium
Call Holder:
- ______ Calls
- ______ Premium
- ______ to BUY or SELL
Call Writer:
- ______ Calls
- ______ Premium
- ______ to BUY or SELL
- Long
- Pays
- Right to BUY
- Short
- Receives
- Obligation to SELL
If the call writer does not own the underlying security that he is obligated to sell at expiration for a predetermined price, he could have a(n) ______ if the price of the security increases substantially. This is because the investor would be required to buy the security at the higher current market price and sell it to the call holder at the lower strike price.
Unlimited Potential Loss
A ______ has the right to sell 100 shares of the underlying security at the strike price (also called the exercise price), until expiration. The ______ pays the premium (price) for the put.
Put Holder
A ______ sells the put short. He has the obligation to buy 100 shares of the underlying security at the strike price, until expiration. The ______ receives the premium.
Put Writer
Put Holder:
- ______ Puts
- ______ Premium
- ______ to BUY or SELL
Put Writer:
- ______ Puts
- ______ Premium
- ______ to BUY or SELL
- Long
- Pays
- Right to SELL
- Short
- Receives
- Obligation to BUY
The main components of an option contract are the underlying ______, the ______ date, the ______ of option, and the ______ price.
- Security
- Expiration
- Type
- Strike
ABC June 30 call at $1.50
ABC = \_\_\_\_\_\_ June = \_\_\_\_\_\_ 30 = \_\_\_\_\_\_ Call = \_\_\_\_\_\_ $1.50 = \_\_\_\_\_\_
ABC = Underlying Security June = Expiration Month 30 = Strike Price Call = Type of Option $1.50 = Premium
The option ______ is not part of the contract. It is the price of the option and fluctuates with the price of the ______ and the time remaining until ______.
- Premium
- Underlying Security
- Expiration
Equity option contracts are for ______ shares of the underlying stock, so you multiply the premium by ______ to get the total premium for the option.
100
The option ______ (______) pays the premium and the option ______ (______) collects the premium.
- Holder (Buyer)
2. Writer (Seller)
______ style options can be exercised at any time up to the cut-off time on expiration day.
American
______ style options can only be exercised during a specific time period, usually the last trading day before expiration.
European
Domestic options on individual stocks, such as Apple, IBM, or Google, are typically ______ style. All domestic equity monthly options expire on the ______ at ______.
- American
- Third Friday of the Month
- 11:59 P.M. ET
Options on stock indexes are generally ______ style. Examples include options on the S&P 500, NASDAQ, or Russell 2000.
European
______-style options are usually more expensive than ______-style options.
- American
2. European
The seller of a(n) ______-style option is assuming more risk because the option buyer can exercise the option at any time. Conversely, ______-style options can only be exercised at expiration, which makes them less expensive. Knowing exactly when the option will be exercised involves less ______ for the option seller.
- American
- European
- Risk
When option holders want to exercise, they must notify their B/D, who in turn notifies the OCC. The OCC assigns a B/D who is short the option contracts that are being exercised, and the B/D notifies a customer with a short position in those options. This is called ______, ______, or ______.
- Being Assigned
- Assignment
- Receiving Notice of Exercise
The OCC assigns broker/dealers at ______ and broker/dealers can assign their customers at ______, on a first in - first out basis, or any other way that is “fair and reasonable.”
Random
______ are nearly identical to conventional equity options except that they represent 10 shares of the underlying security, whereas traditional options represent 100 shares.
Equity Mini-Options
The lower costs of ______ provide a way for investors to participate in the movements of high-priced stocks while buying even just a few shares of a single, expensive traditional option.
Mini-Options
______ are stock or index options with expiration dates out to 39 months.
Long-Term Equity Anticipation Securities (LEAPS)
Only long ______ can result in long-term capital gain or losses. These occur when ______ are held for a period greater than 12 months. Capital gains and losses resulting from a 12-month or shorter holding period are classified as ______.
- Long-Term Equity Anticipation Securities (LEAPS)
- LEAPS
- Short-Term
Conventional options have a(n) ______ life, which always results in ______ capital gains or losses if the option expires or the position is closed.
- 9-Month
2. Short-Term
______ premiums tend to increase in value when the underlying stock price rises, especially as the price of the underlying stock approaches and goes through the strike price.
Call
Investors who are long ______ are ______ on the underlying stock, which means the investor wants the price of the underlying stock to go up.
- Calls
2. Bullish
______ premiums go down in value when the underlying stock goes lower.
Call
______ premiums increase in value when the underlying stock goes down in price, especially as the price of the underlying stock approaches and goes through the strike price.
Put
Investors who are long ______ are ______ on the underlying stock, which means that the investor wants the price of the underlying stock to go down.
- Puts
2. Bearish
______ lose value when the underlying stock rises in price.
Puts
______ are made up of time value and intrinsic value. In equation for, this relationship looks like this:
______ = Intrinsic Value + Time Value
- Options Premiums (Prices)
2. Premium
The ______ of an option is determined by how much time there is until the expiration date. The more time there is until expiration, the more ______ in the option; the less time until expiration, the less ______.
Time Value
The time value of an option “______” the closer it is to the expiration date. Options are ______ assets.
- Erodes
2. Wasting
A(n) ______ has intrinsic value when the price of the underlying security is higher than the strike price of the call.
Call
A(n) ______ has intrinsic value when the price of the underlying security is lower than the strike price of the put.
Put
When an option is “______,” it has intrinsic value. Only ______ options are exercised.
In The Money
A(n) ______ is in the money when the price of the underlying security is higher than the strike price… think “______”.
- Call
2. Call Up
A(n) ______ is in the money when the price of the underlying security is lower than the strike price of the put… think “______”.
- Put
2. Put Down
Intrinsic Value of a ______ Option = Strike Price - Price of Underlying Security
Intrinsic Value of a ______ Option = Price of Underlying Security - Strike Price
- Put
2. Call
The ______ of an in the money option is equal to the difference between the premium and the intrinsic value.
______ = Premium - Intrinsic Value
Time Value
An option is “______” when the market price of the underlying security is the same as the option strike price.
At The Money
The premium of an “at the money” option is made up entirely of ______. An “at the money” option has no ______.
- Time Value
2. Intrinsic Value
A(n) “______” option has no intrinsic value. The premium of an “______” option is made up entirely of time value.
Out Of The Money AND At The Money
A call option is out of the money when the current price of the underlying security is ______ than the strike price of the call.
Lower
A put option is out of the money when the current price of the underlying security is ______ than the strike price of the put.
Higher
An option is at ______ with the underlying stock when the option premium has intrinsic value ONLY. For example, XYZ stock is $62.50, and the XYZ Jan 50 call is $12.50.
Parity
ABC common stock is trading at $50 per share. The ABC April 45 call has a premium of $7. What is the:
- Intrinsic value: ______
- Time value: ______
- $5
- $2
The price of ABC is higher than the strike price of the call, so the call is “in the money.”
$50 (market price) - $45 (strike price) = $5 (intrinsic value)
$7 (premium) - $5 (intrinsic value) = $2 (time value)
LMN is trading at $23 per share. The Dec 25 put has a premium of $2.75. What is the:
- Intrinsic value: ______
- Time value: ______
- $2
- $0.75
The price of LMN is lower than the strike price, so the put is “in the money.”
$25 (strike price) - $23 (market price) = $2 (intrinsic value)
$2.75 (premium) - $2 (intrinsic value) = $0.75 (time value)
Options are issued with a range of expiration dates called ______, of which there are three:
- JAN / APR / JUL / OCT (1, 4, 7, 10)
- FEB / MAY / AUG / NOV (2, 5, 8, 11)
- MAR / JUN / SEP / DEC (3, 6, 9, 12)
Cycles
Actively traded options on ______ may have monthly and even weekly expiration dates in the near term months.
Large Cap Stocks
______ options have more time value than ______ options, simply because there is more time for the underlying stock to move enough to make the option increase in value.
- Far-Dated
2. Near-Dated
Options on volatile stocks will have ______ premiums because volatility increases the likelihood that the stock will move enough for an option to end up in the money.
Higher
Rising interest rates tend to ______ premiums because of ______, meaning that the money could be invested elsewhere, such as in debt instruments.
- Increase
2. Opportunity Cost
Options on each underlying security are issued with a range of ______. Intervals for equity options can be ______, ______, ______, or ______ points apart.
- Strike Prices
2. 1, 2.50, 5, or 10 points
For calls on the same underlying security with the same expiration date, the ______ the call strike price, the ______ the premium.
- Lower
2. Higher
For puts on the same underlying security with the same expiration date, the ______ the put strike price, the ______ the premium.
- Higher
2. Higher
The ______ is the largest options exchange.
- Equity options trade from ______ until ______ Eastern time.
- Options trades settle ______.
- Premiums must be ______; they cannot be purchased on ______.
- The volume of positions in options on any given day will adjust the options ______, which is the number of options contracts open on any given security.
- Chicago Board Options Exchange (CBOE)
- 9:30 AM to 4:00 PM
- Next Business Day (T+1)
- Paid In Full
- Margin
- Open Interest
When an investor enters an order to buy or sell an option contract, the investor must indicate if the order is a(n) ______ transaction or a(n) ______ transaction.
- Opening
2. Closing
A(n) ______ transaction establishes a new option position or adds to an existing position. This transaction can be buy or sell orders.
Opening
A(n) ______ closing transaction closes out or reduces an existing options position. This transaction can be buy or sell orders.
Closing
A(n) ______ order establishes a long position in the options (puts or calls).
Opening Purchase
A(n) ______ order establishes a short position in the options.
Opening Sell
When you write puts and calls, your order is a(n) ______.
Opening Sell
When the long position is sold, the order is a(n) ______.
Closing Sell
It closes out the long position.
When an option writer covers his position by buying back his short option position, the order is a(n) ______.
Closing Purchase
Equity Options expire at ______ on the ______ of the ______.
- 11:59 PM ET
- Third Friday
- Expiration Month
Expiring options stop trading at ______ on the third Friday of the expiration month. Even though options don’t expire until Friday at 11:59 PM ET, the ______ must receive notice of exercise from broker/dealers on Friday no later than ______.
- 4:00 PM ET
- Options Clearing Corporation (OCC)
- 5:30 PM ET
To protect investors, the ______ will automatically exercise expiring options that are in the money by ______ or more. If investors don’t want their in-the-money options to be exercised, they must notify their ______, who must notify the ______ by the exercise deadline.
- Options Clearing Corporation (OCC)
- $0.01
- Brokerage Firm
- OCC
When call holders exercise a call, they ______ stock at the strike price.
Purchase
When put holders exercise a put, they ______ stock at the strike price.
Sell
If an option holder chooses to exercise his option, the option writer must honor his obligation to ______ (if he is short calls) or ______ (if he is short puts) the underlying security.
- Sell
2. Buy
Investors only exercise options that are ______.
In the Money
When ______ holders exercise their options, they will buy the stock at the strike price and the writer must sell the stock at the strike price.
Call
When ______ holders exercise their options, they will sell stock at the strike price and the writer must buy the stock at the strike price.
Put
Stock trades resulting from option exercise settle ______, or ______.
- Regular Way
2. T+2
A simple way to calculate profit and loss for options positions is to use ______ and ______ in a(n) ______.
- Debits
- Credits
- “T” Account
______ represent dollars paid out of the account, and are recorded on the left.
Debits
______ represent dollars received into the account, and are recorded on the right.
Credits
Purchasing an option or stock creates a(n) ______.
Debit
Selling an option or stock results in a(n) ______.
Credit
At the end of an option event, total debits are netted with total credits. A net debit represents a(n) ______. A net credit represents a(n) ______.
- Loss
2. Gain
After you close out of an option position, if you have a larger (net) debit, you have a(n) ______. If your credit is larger, you have a(n) ______.
- Capital Loss
2. Capital Gain
Long Call:
- Maximum Loss: ______
- Maximum Gain: ______
- Breakeven Point: _______
- Maximum Loss: Premium paid.
- Maximum Gain: Unlimited (there is no limit to how high the price of the stock can rise)
- Breakeven Point: Price of Underlying Security = Strike Price + Premium Paid
The market price of XYZ is $39. Jan purchases an out of the money XYZ Nov 40 call for $3.
- Jan’s maximum loss is: ______
- Jan’s maximum gain is: ______
- Jan’s breakeven point is: ______
- $300 maximum loss
$3 (premium) x 100 shares = $300
- Unlimited maximum gain
The price of XYZ could increase to infinity.
- $43 breakeven point
$40 (strike price) + $3 (premium paid) = $43. The price of the stock would need to reach $43 for Jan to break even.
Adam purchased one ABC June 50 call @ $3.50. A month later he sold it for $6. What is his profit or loss?
$250 profit
$6 (sold) - $3.50 (bought) = $2.50
$2.50 x 100 shares = $250
Adam writes on ABC June 50 call @ $3.50. A month later, he buys it back at $6. What is his profit or loss?
$250 loss
$3.50 - $6 = -$2.50
-$2.50 x 100 shares = -$250
Adam bought one ABC June 30 call @ $2.60 when ABC stock was trading at a market price of $31. Subsequently, ABC stock rose to $38 and Adam exercised his call and sold his stock at $38. What is his profit or loss?
$540 profit
$2.60 (debit) + $30 (debit) - $38 (credit) = -$5.40/share (credit)
-$5.40/share (credit) x 100 shares = $540 (credit)
Sally wrote 3 XYZ Oct 50 puts @ $2.25 when XYZ was trading at a market price of $52. At expiration, XYZ is at $57. What is Sally’s profit or loss?
$675 profit
$2.25 x 3 x 100 = $675. The option was not executed since it was not in the money.
Jerry wrote 5 XYZ Oct 50 puts @ $2.25 when XYZ was trading at a market price of $52. At October expiration, XYZ is at $45 and Jerry’s puts are exercised. He immediately sold 500 shares of XYZ at $45. What is his profit or loss?
$1,375 loss
$2.25 (credit) + $45 (credit) - $50 (debit) = -$2.75 (debit)
-$2.75 x 5 x 100 = -$1,375
When the market price of ABC stock is $25.30, your client writes an ABC Jan 25 call for a premium of $3. Subsequently, ABC stock drops to $23 and the client purchases the short call back for $1.
- What is the client’s profit or loss?
- What would the profit or loss be if you client held onto the short call?
- $200 profit
$3 (credit) + $1 (debit) = $2 (credit)
$2 x 100 shares = $200
- $300 profit
$3 (credit) x 100 shares = $300. The call is out of the money so is not executed.
Investors ______ ______ or ______ when they think that the underlying stock price is going to have little or no price movement. If they are correct, they make money gradually as the time value in the option premium decays as it gets closer to the expiration date.
- Write
- Calls
- Puts
Short Call:
- Maximum Loss: ______
- Maximum Gain: ______
- Breakeven Point: _______
- Maximum Loss: Unlimited (the stock price, in theory, can go up to infinity).
- Maximum Gain: Premium received.
- Breakeven Point: Price of Underlying Security = Strike Price + Premium Paid
The market price of XYZ is $39. Jan writes an out of the money XYZ Nov 40 call for $3.
- What is Jan’s maximum gain?
- What is Jan’s maximum loss?
- What is the breakeven price?
- $300 maximum gain
Jan’s maximum gain is the premium received, $3 x 100 = $300
- Unlimited maximum loss
Jan’s maximum loss is unlimited since XYZ can increase in price infinity.
- $43 breakeven point
Breakeven Point –> Price of Security = Strike Price + Premium Paid = $40 + $3 = $43
If the underlying security continues to rise above the breakeven point, the call ______ will profit and the call ______ will lose.
If the stock drops below the breakeven point, the call ______ will profit up to the amount of the premium received, and the call ______ will lose up to the amount of the premium paid.
- Holder
- Writer
- Writer
- Holder
Long Put:
- Maximum Loss: ______
- Maximum Gain: ______
- Breakeven Point: _______
- Maximum Loss: Premium paid.
- Maximum Gain: Strike Price - Premium Paid. The put holder realizes the maximum gain if the underlying stock is $0 at expiration.
- Breakeven Point: Price of Underlying Security = Strike Price - Premium Paid
The market price of XYZ is $39. Jan purchases an out of the money XYZ Nov 35 put for $1.50.
- What is Jan’s maximum gain?
- What is Jan’s maximum loss?
- What is the breakeven price?
- $3,350 maximum gain
$35 (strike) - $1.50 (premium) = $33.50 x 100 shares = $3,350
- $150 maximum loss
$1.50 (premium) x 100 = $150
- $33.50 breakeven point
$35 (strike) - $1.50 (premium) = $33.50
Short Put:
- Maximum Loss: ______
- Maximum Gain: ______
- Breakeven Point: _______
- Maximum Loss: Strike Price - Premium Received. The put writer incurs maximum loss if the stock is 0 at expiration.
- Maximum Gain: Premium received.
- Breakeven Point: Price of Underlying Security = Strike Price - Premium Paid
The market price of XYZ is $39. Jan writes an out of the money XYZ Nov 35 put for $1.50.
- What is Jan’s maximum gain?
- What is Jan’s maximum loss?
- What is the breakeven price?
- $150 maximum gain
$1.50 x 100 = $150
- $3.350 maximum loss
$35 (strike) - $1.50 (premium) = $33.50
$33.50 x 100 = $3,350
- $33.50 breakeven point
$35 (strike) - $1.50 (premium) = $33.50
If the underlying security continues to rise above the breakeven point, the put ______ will lose and the put ______ profits.
If the stock drops below the breakeven point, the put ______ will lose and the put ______ will profit.
- Holder
- Writer
- Writer
- Holder
Max Gain: Infinity
Max Loss: P
BE: SP + P
Long Call
Max Gain: P
Max Loss: Infinity
BE: SP + P
Short Call
Max Gain: SP - P –> 0
Max Loss: P
BE: SP - P
Long Put
Max Gain: P
Max Loss: SP - P –> 0
BE: SP - P
Short Put
Option contracts give both “______” and “______” a way to potentially profit from these anticipated changes in value.
- Bulls
2. Bears
Listed options have a(n) ______ secondary market.
Liquid
Option byers are able to ______ investment dollars by buying control of stock for a relatively small ______, resulting in greater profits on the same investment dollars.
- Leverage
2. Premium
Investors also use options to ______ their stock positions. For example, an investor who is long stock can buy ______ on their stock to protect again a sell-off in the stock.
- Hedge
2. Puts
Investors can also use options to ______ by writing options against their stock positions.
Increase Income
______ refer to the maximum number of option contracts that an individual, a registered representative managing discretionary accounts, or a group of individuals acting together can have on the ______.
- Position Limits
2. Same Side of the Market
The ______ sets position limits for listed options.
Options Clearing Corporation (OCC)
The ______ rules were developed to prevent investors from putting an excessive “bet” on a specific directional move in the market price of a security.
Position Limit
Position limits are intended to prevent ______.
Market Manipulation
Actively traded large capitalization stocks will have ______ position limits than small capitalization stocks.
Higher
Currently, the maximum position limit for the largest capitalized stocks is ______ option contracts on the same side of the market.
250,000
______ are restrictions on the number of options contracts on the same side of the market that can be exercised over ______.
- Exercise Limits
- 5 Consecutive Business Days
The exercise limit is the same as the position limit.
______ are added to put and call positions in determining position limits and exercise limits.
LEAPS (Long Term Equity Anticipation Securities)
______ and ______ are on the same side of the market because they are both bullish positions, therefore, they are added together to determine position limits.
- Long Calls
2. Short Puts
Long calls may be referred to as ______ since an opening purchase is a(n) ______ to a customer’s account.
- Debit Calls
2. Debit
Short puts may be referred to as ______ since an opening sell is a(n) ______ to a customer’s account.
- Credit Puts
2. Credit
______ and ______ are on the same side of the market because they are both bearish positions, therefore, they are added together to determine position limits.
- Long Puts
2. Short Calls
Long puts may be referred to as ______ since an opening purchase is a(n) ______ to a customer’s account.
- Debit Puts
2. Debit
Short calls may be referred to as ______ since an opening sell is a(n) ______ to a customer’s account.
- Credit Calls
2. Credit
Market UP = BULLS
Positions: ______, ______, and ______
- Long Calls [Buy stock, Price Up]
- Short Puts [Buy stock, Price Up]
- Long Stock [Own stock, Price Up]
Market DOWN = BEARS
Positions: ______, ______, and ______
- Short Calls [Sell stock, Price Down]
- Long Puts [Sell stock, Price Down]
- Short Sales [Sold stock, Price Down]
______ that result in a(n) ______ of shares increase the number of options contracts and strike prices are adjusted proportionately lower. The contract size remains the same.
- Stock Splits
2. Whole Number (2:1)
XYZ splits 2:1. One XYZ Nov 40 call contract becomes ______. The contract size remains 100 shares of the underlying security.
2 XYZ Nov 20 Calls
1 (contract) x 2 (split) = 2 contracts
$40 (strike) / 2 (split) = $20 strike
XYZ splits 4:1. One XYZ Nov 40 call contract becomes ______. The contract size remains 100 shares of the underlying security.
4 XYZ Nov 10 Calls
1 (contract) x 4 (split) = 4 contracts
$40 (strike) / 4 (split) = $10 strike
______ ______ leave the number of contracts the same but increase the number of shares per contract and strike prices are adjusted proportionately lower.
- Fractional (3:2)
2. Stock Splits
ABC splits 3:2. The ABC June 60 call becomes a(n) ______ with a contract size of ______ of the underlying security.
- ABC June 40 call
2. 150 shares
______ and ______ increase option contract size. Strike prices are adjusted proportionately ______.
- Fractional Stock Splits
- Stock Dividends
- Lower
______ is an investment strategy that investors use to protect their investments against loss and control risk. It involves reducing risk associated with an investment by using a second investment to offset a potential loss on the first.
Hedging
An investor could protect a long stock position by purchasing ______ on the stock that they own. This is known as a(n) ______ purchase.
- Put
2. Protective Put
You buy 100 shares of ABC stock for $41 a share and purchase an ABC June 40 put @ $2.50.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: Unlimited, since you own the stock.
- Maximum Loss: $350
$41 (bought price) - $40 (put price) = $1 (net loss)
$1 x 100 shares = $100
$2.50 (premium paid) x 100 shares = $250
$100 + $250 = $350
- $43.50
The breakeven point on the stock occurs when the price of the stock is equal to the price paid for the stock plus the premium paid for the put.
$41 (price paid) + $2.50 (premium) = $43.50
You make money on this position if the stock rises above $43.50 and you lose if the stock is below it.
Investors can buy ______ to protect a substantial profit on an established long stock position.
Puts
You can protect a short stock position by purchasing ______ on your short stock. This is called a(n) ______ purchase.
- Calls
2. Protective Call
You sell short 100 shares of XYZ stock at $62 and purchase one Sept $65 call for $1.80.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $6,020
Price stays below $65.
[ $62 (sold price) - $1.80 (premium) ] x 100 shares = $6,020.
- Maximum Loss: $480
Price rises above $65.
[ $65 (call price) - $62 (sold price) + $1.80 (premium) ] x 100 shares = $480
- Breakeven Point: $60.20
The breakeven point on the stock is when the price of the stock is equal to the short sale price for the stock less the premium paid for the call.
$62 (sold price) - $1.80 (premium) = $60.2
A(n) ______ provides a stock investor with a partial hedge AND income. To establish a(n) ______, an investor ______ options share for share against a stock position and ______ the premium.
- Covered Write
- Covered Write
- Writes
- Collects
An investor who is long stock establishes a(n) ______ by writing calls on a stock position. The calls are “______” because the investor owns the underlying security.
- Covered Write
2. Covered
______ provides income to the investor and creates a partial downside hedge but limits the investor’s potential profit on the stock.
Writing Calls
An investor purchases 100 shares of LMN at $43 and writes one LMN Sept $45 call @ $2.25.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $425
[ $45 (sell) - $43 (bought) + $2.25 (premium) ] x 100 shares = $425
The investor purchased stock at $43. If it rises above $45, the investor is assigned on the short call and has to sell the stock at $45 for a gain of $200. The premium of $225 was received for writing the call.
- Maximum Loss: $4,075
[ -$43 + $2.25 ] x 100 shares = -$4,075
If LMN goes to zero, then the investor loses the $4,300 paid for the stock less the $225 premium received for writing the call.
- Breakeven Point: $40.75
$43 (bought price) - $2.25 (premium) = $40.75
The breakeven point on the stock is equal to the price paid for the stock less the premium received for the call.
Below $40.75, the investor loses money, thus writing the call provides only a partial hedge on the downside risk of the stock.
If the investor writes a(n) ______ on a stock that pays a dividend, it increases the likelihood of early exercise near or on the dividend record date. If the ______ is in the money, especially if it is at or near intrinsic value, the ______ might exercise the ______ in order to collect the dividend.
- Covered Call
- Call
- Call Holder
- Call
When the dividend is ______ than the time value in the option premium, exercise is ______ likely.
- Greater
2. More
An investor establishes a(n) ______ on a short stock position by writing ______ on a short stock position. Writing ______ provides the investor with income, a partial hedge, and limits the investor’s potential profit on the position.
- Covered Write
- Puts
- Puts
An investor sells short 100 shares of ABC at $72 and writes one ABC June 70 put @ $3.35.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $535
[ $72 (sold price) - $70 (put price) + $3.35 (premium) ] x 100 = $535
- Maximum Loss: Unlimited, the investor is short stock.
- Breakeven Point: $75.35
$72 + $3.35 = $75.35
The breakeven point on the stock is equal to the short sale price of the stock plus the premium received for writing the put. If the stock rises above $75.35, the investor loses money and the potential loss is unlimited, thus writing the put provides only a partial hedge on the upside risk of the stock.
Remember that to hedge a stock position, you have to establish an options position on the ______ of the market. ______ put and calls provide more protection than ______ which give you a partial hedge and income.
- Opposite Side
- Protective
- Covered Writes
Stock Position: Long Stock
Hedge (protective call or put): ______
Partial Hedge (covered write): ______
Hedge: Long Put
Partial Hedge: Short Call
Stock Position: Short Stock
Hedge (protective call or put): ______
Partial Hedge (covered write): ______
Hedge: Long Call
Partial Hedge: Short Put
Investors who own stock are considered ______, meaning they want the market to go up. In order to provide a hedge, the investor could either buy a(n) ______ (right to sell) or write a(n) ______ (obligation to sell).
- Bullish
- Put
- Call
Investors who are short a stock are considered ______, meaning they want the market to go down. To hedge a short position, the investor can either buy a(n) ______ (right to buy) or sell a(n) ______ (obligation to buy).
- Bearish
- Call
- Put
______ is the first option position that a new option investor is allowed to do.
Covered Call Writing
A(n) ______, in the case of long stock, is when investors write more calls than they have stock. The investor receives more premium but is exposed to unlimited risk on the short call. In the case of short stock, an investor writes more puts than they have short stock.
Ratio Write
Long 100 ABC @ $35 and short 2 ABC $40 calls @ $1.25.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $750, if the stock is $40 at expiration. The investor will keep the $250 premium for the 2 short calls, and make $500 on the stock.
[ $40 (strike) - $35 (bought) + $1.25 (premium) x 2 ] x 100 shares = $750
- Maximum Loss: Unlimited, there is an uncovered short call.
- Breakeven Point: $32.50 on the downside. Above $32.50, the investor makes money until the stock reaches $37.50 [$35 + $2.50 (premium received)], and then starts losing on the uncovered short call.
$35 - [ $1.25 (premium) x 2 ] = $32.50
Short 100 XYZ @ $53 and short 2 XYZ April 50 puts @ $2.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $700. At expiration, if the market price of XYZ is $50, the investor makes $300 on the stock and keeps the $400 premium for the two short puts.
[ $53 (short) - $50 (put) + $2 x 2 ] x 100 = $700
- Maximum Loss: Unlimited, the investor is short stock.
- Breakeven Point: $57 on the upside. Above $57, the investor loses money on the short stock. Below $49, the investor loses on the uncovered short put.
$53 + $4 = $57 on the upside, $53 - $4 = $49 on the downside
Claudette purchases 300 shares of ABC stock @ $24 and writes 3 ABC Jan 25 calls @ $1.75. At January expiration, ABC is $27.50. What is Claudette’s profit or loss?
$825 profit
[ $1.75 (premium) - $24 (buy) + $25 (strike) ] x 300 shares = $825
She purchased stock at $24. She received a premium of $1.75 for her short calls. At expiration, her short calls are exercised and she has to sell her stock at $25.
Jay bought 100 shares of XYZ @ $28 and purchased one XYZ Feb 25 put for $0.88. At February expiration, XYZ is $27 and Jay closes out his entire position. What is his profit or loss?
$188 loss
Debits: $28 (buy) + $0.88 (premium)
Credits: $27 (sell)
[ $27 (sell) - $28 (buy) - $0.88 (premium) ] x 100 shares = -$188
Jay lost $188. He bought 100 shares of XYZ at $28; a debit and sold it for $27; a credit. He paid $0.88 for his long put; a debit. At expiration the put was out of the money and expired worthless.
Maria sold short 100 shares of ABC @ $52. She bought one ABC April 55 call @ $1.40. ABC falls to $46 and Maria buys back the short stock and sells her long call for $0.32. What is her profit or loss?
$492 profit
Debit: $1.40 (premium), $46 (buy)
Credit: $52 (sold), $0.32 (premium)
[ $52 + $0.32 - $1.40 - $46 ] x 100 shares = $492
Maria made a profit of $492. She shorted stock at $52, a credit, and bought it back at $46, a debit. She paid $1.40 for the long call, a debit, and sold it for $0.32, a credit.
A(n) ______ is an options strategy that uses long and short options of the same type - either puts or calls - on the same underlying security.
Spread
One type of ______ (price) spread is a(n) ______ spread.
______ means that the investor buys one call and sells another call with a different strike price.
______ means that the investor is establishing the spread for a net debit; money is being paid to establish the spread.
- Vertical
- Debit Call
- Vertical
- Debit
To establish a(n) ______, an investor buys a call with a lower strike price and writes a call with a higher strike price.
Debit Call Spread
A debit call spread has ______ risk than owning a call. A debit call spread is a(n) ______ position.
- Less
2. Bullish
Buy one ABC Jan 30 call @ $2.25. Write one ABC Jan 35 call @ 1.00.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $375
Debit: $30 (buy), $2.25 (premium)
Credit: $35 (sell), $1.00 (premium)
- Maximum Loss: $125
Debit: $2.25 (premium)
Credit: $1.00 (premium)
- $30 + $2.25 - $1.00 = $31.25
For a debit call spread, the breakeven point on the stock is equal to the lower strike plus the net premium paid for the spread. The investor loses money below $31.25 and makes money above it.
The market price of DEF is $31. Gordon bought 5 DEF Dec 30 calls @ $3.00 and wrote 5 DEF Sept 30 calls for $1.75. At September expiration, DEF is 29 and the Sept 30 calls expire. If Gordon sells his DEF Dec 30 calls for $2, what is his profit or loss?
$375 profit
Debit: $3.00 (premium)
Credit: $1.75 (premium), $2 (premium)
[ $1.75 + $2 - $3 ] x 500 shares = $375
A(n) ______ or ______ spread occurs when there is a difference in the expiration date as opposed to the strike prices.
- Horizontal
2. Calendar
Juan thinks that ABC stock is going higher. He wants to buy 5 ABC Feb 40 calls @ $4.25, but he is worried about losing his entire investment of $2,125. To minimize his potential loss, he decides to create a call spread and writes 5 ABC Feb 50 calls @ $1.00, for a net premium of $3.25. A month later, he closes the entire position for $6. What is his profit or loss?
$1,375 profit
Debit: $4.25 (premium)
Credit: $1.00 (premium), $6.00 (premium)
[ $1.00 + $6.00 - $4.25 ] x 500 shares = $1,375
Juan purchased the call spread (he bought the lower strike price call) for a net premium of $3.25 and sold it for a net premium of $6.
______ means that the investor is establishing the spread for a net credit; he’s receiving a premium.
Credit
To establish a(n) ______, an investor writes the call with the lower strike price and purchases the call with the higher strike price. Because the investor is writing the more expensive call, a(n) ______ is received for the spread.
- Credit Call Spread
2. Net Premium
A credit call spread is a(n) ______ position. The investor wants the underlying security to go ______.
- Bearish
2. Down
Under a(n) ______, the spread loses value or “narrows” as the price of the underlying stock falls to or below the lower strike price call. The investor realizes the maximum gain at expiration if both calls expire and he keeps the premium received.
Credit Call Spread
Write one LMN May 50 call @ $7.50. Buy one LMN May 60 call @ $1.50.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $600, which is the premium received if both options expire.
Credit: $7.50 (premium)
Debit: $1.50 (premium)
[ $7.50 - $1.50 ] x 100 shares = $600
- Maximum Loss: $400, for a credit call spread is the strike price interval of the spread less the premium received.
Credit: $7.50 (premium), $50 (sell)
Debit: $1.50 (premium), $60 (buy)
[ $7.50 + $50 - $1.50 - $60 ] x 100 shares = -$400
- Breakeven Point: $56, for a credit call spread, the breakeven point on the stock is equal to the lower strike plus the premium received for the spread. The investor loses money above $56 and makes money below $56.
Recently, XYZ stock shot up to 15 points to $43 on takeover rumors. Fred thinks the rumors are wrong and XYZ is going lower. He wants to write a call, but he is concerned about the upside risk, if he’s wrong and XYZ gets bought out at a higher price. He decides to control his risk and put on a credit call spread instead. Fred sells one XYZ March 40 call @ $5 and buys one XYZ March 50 call @ $1.50. A week later, XYZ is $29 and Fred closes his position for a net debit of $0.10. What is Fred’s profit or loss?
$340 profit
Credit: $5 (premium)
Debit: $1.5 (premium), $0.10 (net debit)
$5 - $1.5 - $0.10 = $340
To establish a(n) ______, the investor buys a put with a higher strike price and sells a put with a lower strike price.
Debit Put Spread
A debit put spread is a(n) ______ position. The investor wans the underlying security to go ______.
- Bearish
2. Down
Under a(n) ______, the spread increases in value or “widens” as the underlying stock falls to and goes through the lower strike price put and the probability of exercise increases. The maximum gain is realized at expiration if both puts are exercised.
Debit Put Spread
Buy one XYZ Jan 70 put @ $4.25. Write on XYZ Jan 60 put @ $1.05.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $680. At January expiration, if XYZ is $60 or lower, he will sell stock at $70 and buy it at $60 for a $1,000 gain less the $320 premium paid for the spread.
Credit: $1.05 (premium), $70 (sell)
Debit: $4.25 (premium), $60 (buy)
$70 + $1.05 - $4.25 - $60 = $6.8 x 100 = $680
- Maximum Loss: $320, which is the net premium paid assuming both options expire worthless.
Credit: $1.05 (premium)
Debit: $4.25 (premium)
$1.05 - $4.25 = -$3.2 x 100 = -$320
- Breakeven Point: $66.80. For a debit put spread, the breakeven point on the stock is equal to the higher strike less the net premium paid for the spread. The investor loses money above $66.80 and makes money below it.
$60 + $3.20 (debit spread) = $63.20
Under a(n) ______, the investor is establishing the spread for a net credit; premium is received.
Credit Put Spread
To establish a(n) ______, an investor writes the put with the higher strike price and purchases the put with the lower strike price.
Credit Put Spread
A credit put spread is a(n) ______ position. The investor wants the underlying security to go ______.
- Bullish
2. Higher
Under a(n) ______, the spread loses value or “narrows” as the price of the underlying stock rises to or goes through the higher strike price put. The investor realizes the maximum gain at expiration if both puts are out of the money and expire worthless. If that happens, the investor keeps the premium received.
Credit Put Spread
Write one LMN May 50 put @ $5.70. Buy one LMN May 45 put @ $2.40.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point?
- Maximum Gain: $330, which is the premium received if LMN is above 50 and both puts expire worthless.
Credit: $5.70 (premium)
Debit: $2.40 (premium)
- Maximum Loss: $170, which for a credit put spread is the strike price interval of the spread less the premium received.
Credit: $45 (sell), $5.70 (premium)
Debit: $50 (buy), $2.40 (premium)
- Breakeven Point: $46.70
$50 - $5.70 + $2.40 = $46.70
For a credit put spread, the breakeven point on the stock is equal to the higher strike less the premium received for the spread. The investor loses money below $46.70 and makes money above $46.70.
Betty wrote one DEF Jan 70 put @ $7 and bought one DEF Jan 60 put @ $1.60. At January expiration, both puts are in the money. What is Betty’s profit or loss?
$460 loss
Credit: $7 (premium), $60 (sell)
Debit: $1.60 (premium), $70 (buy)
$60 + $7 - $70 - $1.60 = -$4.60 x 100 shares = -$460
______ are vertical spreads where the investor writes extra of the out of the money options.
Ratio Spreads
The investor collects more premium, but also has more risk. A(n) ______ exposes the investor to unlimited upside risk from the uncovered call. A(n) ______ exposes the investor downside risk (strike price - premium received) on the uncovered put.
- Ratio Call Spread
2. Ratio Put Spread
The current market price of ABC stock is $36. Barney thinks ABC stock is going lower and he’d like to buy ABC at $25, so he put on the following ratio spread: Buy 4 ABC June 35 puts @ $2 and write 8 ABC June 25 puts @ $0.25. A month later, the market price of ABC is $24. Barney is exercised on the short puts and he sells his long puts. What is Barney’s new position, and assuming intrinsic value, what is his profit or loss on his options position?
SPREAD:
Credit:
Debit:
SHORT PUTS (4 extra):
Credit:
Debit:
The current market price of ABC stock is $36. Barney thinks ABC stock is going lower and he’d like to buy ABC at $25, so he put on the following ratio spread: Buy 4 ABC June 35 puts @ $2 and write 8 ABC June 25 puts @ $0.25. A month later, the market price of ABC is $24. Barney is exercised on the short puts and he sells his long puts. What is Barney’s new position, and assuming intrinsic value, what is his profit or loss on his options position?
Barney is long 800 shares ABC @ $25/share. He profited $3,000 from his options position.
Credit: $0.25x800 (premium), (35-24)x400 (sell)
Debit: $2.00x400 (premium), (25-24)x800 (buy)
$200 + $4,400 - $800 - $800 = $3,000
______ have the same expiration date but different strike prices. They can be established with calls or puts. ______ reduce some of the risks associated with buying and writing puts and calls; however, they also reduce the profit potential.
Vertical Spreads
______ have the same expiration date but different strike prices. They can be established with calls or puts. ______ reduce some of the risks associated with buying and writing puts and calls; however, they also reduce the profit potential.
Vertical Spreads
______ can be established for a debit or credit.
Vertical Spreads
A(n) ______, also called a(n) ______ or a(n) ______, is an options strategy wherein an investor writes a near term option and buys far dated option of the same type, with the same strike price on the same underlying security. In other words, the only difference between the two options is the expiration date.
- Calendar Spread
- Horizontal Spread
- Time Spread
The investor who purchases a(n) ______ believes that there will be very little volatility on the underlying stock in the near term. If correct, the short term option will lose value at a faster rate than the long far dated option, especially during the month leading up to the expiration when time value tends to erode quickly. If the underlying security is at the strike price when the near term option expires, it will be worthless. Then the investor may choose to continue to hold the long option or sell it.
Calendar Spread / Horizontal Spread / Time Spread
A(n) ______ is a call and a put on he same underlying security with the same strike price and the same expiration date.
Staddle
The investor buying or writing a(n) ______ is speculating on the volatility of the underlying security.
Straddle
The buyer of the ______ expects the underlying security to make a substantial move, but is not sure if the move will be up or down, so the investor buys a put and a call with the same strike price and expiration date.
If the underlying security goes high enough, the investor makes money on the ______; if it goes low enough, the investor makes money on the ______.
- Straddle
- Long Call
- Long Put
The seller/writer of a(n) ______ expects little or no volatility in the movement of the underlying security. If correct, the ______ writer makes money because the option premiums will gradually go down in value because of the decline in volatility and the erosion of the time value in the put and call premiums.
Straddle
Long Straddle:
- Maximum Gain: ______
- Maximum Loss: ______
- Breakeven Point (Upside): ______
- Breakeven Point (Downside): ______
- Unlimited (because a straddle holder is long calls).
- Premium Paid
- Upside: Premium of the call and the put added to the call strike price.
- Downside: Premium of the call and the put subtracted from the put strike price.
Short Straddle:
- Maximum Gain: ______
- Maximum Loss: ______
- Breakeven Point (Upside): ______
- Breakeven Point (Downside): ______
- Premium Received.
- Unlimited (because straddle writer is short calls).
- Upside: Premium of the call and the put added to the call strike price.
- Downside: Premium of the call and put subtracted from the put strike price.
A straddle ______ makes a profit if the underlying security trades above or below the breakeven points.
Holder
A straddle ______ makes a profit if the underlying security trades in between the breakeven points.
Writer
Assume the market price of XYZ is 50. Thomas expects XYZ to be volatile but is not sure whether it will go up or down. Thomas places an order to buy 10 XYZ August 50 straddles in which is executed as follows:
Buy 10 XYZ August 50 Calls at 3
Buy 10 XYZ August 50 Puts at 3.25
- What is the breakeven point for the call/upside?
- What is the breakeven point for the put/downside?
- What is the maximum profit on the call side?
- What is the maximum profit on the put side?
- What is the maximum loss?
- $56.25 (call/upside) breakeven point
$3.00 + $3.25 = $6.25 total premiums
$50 (call strike) + $6.25 = $56.25
- $43.75 (put/downside) breakeven point
$50 (put strike) - $6.25 = $43.75
- Unlimited, the security price could rise to infinity.
- $43,650, if XYZ goes to zero.
[ $50.00 - $3.00 - $3.35 ] x 10 x 100 shares
- $6,350 loss if the options expire worthless.
[ $3.00 + $3.35 ] x 10 x 100 shares
Assume the market price of XYZ is 50. Thomas expects XYZ to be stable and not swing too far up or down. Thomas places an order to write 10 XYZ August 50 straddles in which is executed as follows:
Write 10 XYZ August 50 Calls at 3
Write 10 XYZ August 50 Puts at 3.25
- What is the breakeven point for the call/upside?
- What is the breakeven point for the put/downside?
- What is the maximum profit?
- What is the maximum loss on the call side?
- What is the maximum loss on the put side?
- $56.25 (call/upside) breakeven point
$3.00 + $3.25 = $6.25 total premiums
$50 (call strike) + $6.25 = $56.25
- $43.75 (put/downside) breakeven point
$50 (put strike) - $6.25 = $43.75
- $6,250 gain, if the options expire worthless.
[ $3.00 (premium) + $3.25 (premium) ] x 10 x 100 shares = $6,250
- Unlimited, shorted call. The price could rise to infinity.
- $43,750 loss, if the price of XYZ goes to zero.
[ $3.00 (premium) + $3.25 (premium) - 50 (strike) ] x 10 x 100 shares = -$43,750
The market price of ABC stock is 41. ABC stock is reporting earnings next week. Kyle thinks the price of ABC will move up substantially on a good earnings report and down substantially on a poor one. He decides to buy 5 ABC Oct 40 straddles @ $4.25 ($2.50 for the calls and $1.75 for the puts). ABC reports excellent earnings and the stock shoots up to 49. Kyle sells his long straddles for $9.75. What is his profit or loss?
$2,750 profit
Credit: $9.75 (sold)
Debit: $4.25 (premiums)
$9.75 - $4.25 = $5.50 x 5 x 100 shares = $2,750
The current market price of LMN stock is $24.50. A month ago, Tina bought 200 shares of LMN @ 24. Tina thinks that LMN is going to stay in a narrow trading range for a long time and decides to write 2 Jan 25 straddles @ $3.50 ($1.50 for the calls and $2 for the puts). Surprise! LMN gets bought out for $32 a share. What is Tina’s profit or loss on the entire position at January expiration?
$900 profit
Credit: $3.50 (premiums)
Debit: [ $25 (strike) - $24 (bought) = $1 ] (net change)
[ $3.50 + $1 ] x 2 x 100 shares = $900
The market price of XYZ stock is $51.25. Sarah writes 10 XYZ Nov 50 straddles for $5.75 ($3.50 for the calls and $2.25 for the puts). On the Friday before November expiration, XYZ is trading at $50.12 and Sarah’s straddle is @ $0.25 ($0.20 for the calls and $0.05 for the puts). She doesn’t want to get assigned on the short calls (or the short puts, if the stock should fall below 50 before the stock market closes, so she makes a closing purchase of the straddle of @ $0.25. What is her profit or loss?
$5,500 profit
Credit: $5.75 (premiums)
Debit: $0.25 (closing purchase)
$5.75 - $0.25 = $5.50 x 10 x 100 = $5,500
Like a straddle, a(n) ______ is a strategy for speculating on the volatility of the underlying stock. A(n) ______ is similar to a straddle in that it involves buying or selling a call and a put on the same underlying stock. However, the contracts have different strike prices and/or different expiration months.
Combination
Buy 5 ABC June 45 Calls at $0.75.
Buy 5 ABC June 35 Puts at $0.90.
- What is the maximum gain?
- What is the maximum loss?
- What is the breakeven point on the upside?
- What is the breakeven point on the downside?
- Maximum Gain: Unlimited.
The maximum gain for a long combination is unlimited because the combination holder is long calls.
- Maximum Loss: $825, equal to the combined premiums paid for the puts and calls.
$0.90 + $0.75 (premiums) = $1.65 x 5 x 100 = $825
- Breakeven Point (call/upside): $46.65
- Breakeven Point (put/downside): $33.35
$1.65 (premiums) + $45 (call strike) = $46.65
$35 (put strike) - $1.65 (premiums) = $33.35
The holder of this combination will make money if ABC stock goes above $46.65 or below $33.35.
The largest option exchange is the ______.
Chicago Board Options Exchange (CBOE)
______ are scattered throughout the trading floor where options on stocks, indexes, and other securities trade.
Trading Posts
Option orders are transmitted to the trading floor via the CBOE’s ______, which is an automated execution system that allows member firms to transmit option orders directly to the trading post. When these orders are executed, the system automatically notifies the member firm of the completed transaction.
Order Support System (OSS)
At each trading post, there is a(n) ______ who keeps track of public limit orders and oversees the opening and closing of the trading day. The ______ works for the exchange and cannot trade for his own account.
Order Book Official (OBO)
On the trading floor, there are also ______ and ______, who both execute trades for customers.
- Floor Brokers
2. Market-Makers
There are ______ Floor Brokers and Floor Brokers who are ______ of member firms who execute orders for their firm’s customers.
- Independent
2. Employees
______ are members of the exchange who trade for their own account. A(n) ______ will make bids and offers for options when there is a shortage of public orders; they literally make markets.
Market Maker(s)
The ______ regulates how options are traded.
Chicago Board Options Exchange (CBOE)
In order to promote an orderly market open in options trading, each options series goes through a(n) ______. The ______ opens trading by calling for Bids and Offers for each series. This establishes a(n) ______ for each options series. Only after all series have gone through the trading rotation will all options series be available for ______.
The converse holds true at the market close: Each ______ goes through a(n) ______ to get ______ Bids and Offers.
- Opening Rotation
- Order Book Official (OBO)
- Opening Price
- Open Trading
- Series
- Closing Rotation
- Closing
A(n) ______ is defined as all options of one issuer with the same class (all calls of one issuer or all puts of one issuer are another), exercise price, and expiration month.
Options Series
A(n) ______ on a particular stock will not open or start trading until the underlying stock is trading at its primary market, i.e. on the exchange, NASDAQ, etc.
Option
______ Rule: When trading is ______ on a stock, trading in options on that stock is ______ by the options exchange.
- Trading Halts
- Halted
- Halted
______ Rule: ______ cannot be used to cover short calls.
Restricted Stock
______ Rule: Member firms have to ______ to the exchange information about members, employee, and customer accounts that have ______ or more option contracts on the same side of the market. This doesn’t constitute a position limit violation; it’s only a(n) ______ requirement.
- Reporting
- Report
- 200
- Reporting
Each option account must be approved by a(n) ______ prior to trading.
Registered Options Principal (ROP)
All option account activity must be approved by a(n) ______.
Registered Options Principal (ROP)
A(n) ______ is a principal who is qualified and registered to supervise options activity.
Registered Options Principal (ROP)
When a customer account is approved for option activity, the customer is given the ______.
Option Disclosure Document
The ______ details the risks involved in trading options and must be sent to the customer ______ or ______ to ______ by the ROP. This document is prepared by the ______.
- Option Disclosure Document
- At or Prior to Account Approval
- Options Clearing Corporation (OCC)
The ______ is given to the options customer and the customer must sign and return it within ______ of receipt. When customers sign the ______, they must verify net worth, annual income, and that they’ve read and understood the ______. They also confirm that they understand their approved level of trading and will abide by the ______ imposed by the exchange.
- Option Agreement
- 15 Days
- Option Agreement
- Options Disclosure Document
- Position Limits
If the account is to be a(n) ______ account in which the registered representative or the member firm can decide either the ______ (buy or sell), the ______ (# of contracts), or the ______ (contract), the account must be approved as ______. The firm must have written ______ authority from the customer.
- Discretionary
- Action
- Amount
- Asset
- Discretionary
- Discretionary
______ accounts have to be reviewed more frequently by the ROP.
Discretionary
Unless the customer is buying options only, a(n) ______ must be signed and ROP-approved prior to the first ______ trade.
Margin
When customers buy a(n) ______, they must pay in full and not borrow any money. However, if the ______ position is covered, it can be done in the cash account.
Option
Short options are considered ______ if the investor has the cash in the account.
Covered
To open an options account, the following must occur in the order stated:
- ______ completed.
- ______ agreement and ______ agreement must be fully executed unless the customer is only buying options.
- ______ must be provided prior to the registered option principal approving the account.
- The customer return the signed ______ to the brokerage firm within ______ of the new account approval. However, if the customer is late signing the ______ and sending it back, only closing transactions may occur.
- New Account Form
2a. Customer Loan Agreement
2b. Margin Agreement
- Options Disclosure Document
4a. Options Account Agreement
4b. 15 Days
4c. Option Agreement
Option advertising must be approved by a(n) ______ prior to first use. It must be filed with the ______ at least ______ prior to use. Advertising may not address any specific option or performance.
- Registered Options Principal (ROP)
- Self-Regulatory Organization (SRO)
- 10 Days
Option ______, which is must more specific than advertising, must be approved in advance by a registered options principal.
Sales Literature
Whenever sending out option sales literature, the registered representative or the broker/dealer is also required to send a copy of the ______. This document discloses the risks involved in trading options.
- Options Clearing Corporation (OCC) Disclosure Document
Options are ______ and subject to ______ tax treatment.
- Capital Assets
2. Capital Gains
If puts or calls are purchased and held for more than a year, the profit or loss on the sale is treated as a(n) ______ ______.
- Long-Term
2. Capital Gain or Loss
If puts or calls are purchased and held for less than a year, the profit or loss on the sale is treated as a(n) ______ ______.
- Short-Term
2. Capital Gain or Loss
Long puts and calls that expire are treated as a(n) ______ for tax purposes. The expiration date is the ______.
- Sale
2. Sale Date
Exercising options is not a(n) ______ event. When a call holder exercises and purchases the underlying security, a new ______ period begins the day after he exercises the call. The ______ for the stock is the strike plus the premium paid for the call.
- Taxable
- Tax Holding
- Cost Basis
Exercising options is not a(n) ______. When a put holder exercises and sells the underlying security, the ______ equal the strike price less the premium paid for the put. This is compared to the investor’s ______ to determine capital gain or loss.
- Taxable Event
- Sales Proceeds
- Stock Purchase Price
Income from writing puts and calls is treated as a(n) ______ regardless of how long the investor held the position. It is included in income when the option position is ______, either from a closing purchase or expiration.
- Short-Term Capital Gain
2. Closed
If a call writer is exercised, the sale proceeds equal the ______ plus the ______ . The tax treatment of the profit or loss depends on how long the investor held the ______.
- Strike Price
- Premium Received
- Underlying Security
If a put writer is exercised, the cost basis is established for the underlying security purchased. This cost basis equals the ______ less the ______. The tax holding period for this new stock position begins ______.
- Strike Price
- Premium Received
- The Day After The Purchase
Profits and losses from long LEAPS (held for more than 1 year) are treated as ______. Income from writing LEAPS is treated as a(n) ______ regardless of the holding period.
- Long-Term Capital Gains and Losses
2. Short-Term Capital Gain
______ are contracts on assets other than equities. Breakeven, gain, and loss are calculated the same way. Long calls and short puts are ______. Short calls and long puts are ______. The ______ is in control and the ______ is obligated to perform if instructed.
- Nonequity Options
- Bullish
- Bearish
- Holder
- Writer
listed put and call options are traded on ______ like the S&P 500 and the S&P 100 (OEX) as well as ______ that track specific market sectors such as the XOI (Oil Index).
- Broad-Based Indices
2. Narrow-Based Indices
______ allow investors to capitalize on price movements of the stock market as a whole or stock market sectors, and can be used to hedge a portfolio of stocks.
Index Options
______ trade on the AMEX, CBOE, ISE, NYSE Arca, and the PHLX.
Index Options
Usually, index options have a contract multiplier of ______.
100
When index options are exercised, they settle in ______, not ______. This is called ______.
- Cash
- Securities
- Cash Settlement
The index option holder receives cash equal to the ______ of the option. The index option writer is required to deliver cash equal to the ______ of the option, on the ______ business day.
- Intrinsic Value
- Intrinsic Value
- Following
The exercise settlement value is based on the ______ or the ______ (depending on the index) of the underlying index on the _______ the option is exercised.
- Closing Value
- Opening Value
- Day
______: Exercise settlement values are based on the value of the underlying index at the market open.
AM Settlement
______: Exercise settlement values are based on the value of the underlying index at the market close.
PM Settlement
An investor exercises an OEX Oct 530 call. The closing value of the OEX (S&P 100) on the day of exercise is 537.
The investor will receive ______.
The call writer must deliver ______ on the _______.
- $700
- $700
- Next Business Day
$537 (exercise) - $530 (strike) = $7 x 100 contract multiplier = $700
In reality, investor’s don’t usually exercise ______. Why bother exercising an option that settles in ______ when you can just sell it for cash in the options market? Plus, when you sell options, the premium will include the remaining ______.
- Index Options
- Cash
- Time Value
Most index options are _______, meaning they may only be exercised during a specified time period just prior to expiration (usually on Friday). Options on the S&P 500 are _______.
European Style
______ may be exercised any time up to the exercise cut-off time on expiration day. OEX (S&P 100) are ______.
American Style
American style index options expire on the ______ of the month. For European style index options, expiration is the business day ______ the day that the exercise settlement is calculated (usually a(n) ______).
- Third Friday
- Before
- Thursday
Trading hours for broad-based indices options are ______ to ______ .
9:30 A.M. to 4:15 P.M.
Industry-Specific Indices: 9:30 A.M. to 4:00 P.M.
Industry specific indices trade from ______ to ______.
9:30 A.M. to 4:00 P.M.
Broad-Based Indices: 9:30 A.M. to 4:15 P.M.
Index options trades settle ______.
On The Next Business Day
Four time per year, in ______, ______, ______, and ______, three types of options expire on the same. These options are ______, ______, and ______. This occurrence is known as ______.
- March, June, September, and December
- Stock Options
- Index Options
- Options on Futures
- Triple Witching
Triple witching days are generally associated with _______.
Volatility
Currently, there are no _______ on broad-based index options; however, this is subject to change. There are ______ for exchange members, regarding member firms and their customers who hold large positions in broad-based index options.
- Position Limits
2. Reporting Requirements
You cannot do a(n) ______ on an index because there is no _______.
- Covered Write
2. Underlying Stock
Investors and portfolio managers buy ______ to insure stock portfolios against market downturns and to protect unrealized gains.
Index Puts
To insure a portfolio of small- and mid-cap stocks, an investor might buy index puts on the ______. To insure a diversified portfolio of large cap stocks, ______ index puts might be chosen.
- Russell 2000
2. S&P 500
To calculate how many puts to insure a portfolio, divide the ______ of the portfolio by the ______ x ______.
- Dollar Value
- Index Value
- Contract Multiplier
______ = Portfolio Value / (Index Value + Contract Multiplier)
Number of Puts to Insure a Portfolio
An investor owns a portfolio of large cap stocks worth $735,000 with a substantial unrealized gain. The investor wants to “insure” the portfolio and decides to purchase OEX Jan 475 puts. The current index value is 490. How many puts must be purchased?
15 Puts
$735,000 (portfolio value) / [ 490 (index value) x 100 (contract multiplier) ] = 15
______ is a measurement of how closely the volatility of a stock, or a portfolio of stocks, follows the overall market.
Beta
A stock or portfolio with a beta of ______ has the same volatility as the overall stock market. If it has a beta of ______, it is 25% less volatile. If it has a beta of ______, it is 25% more volatile than the market.
- 1
- 0.75
- 1.25
If the beta of their portfolio is ______ than the market, portfolio managers need to purchase more ______ to hedge their portfolio.
- Higher
2. Puts
To hedge a portfolio with a beta of 1.10, the manager needs to purchase ______ more puts. A portfolio of 1.20 needs ______ more puts, etc.
- 10%
2. 20%
Portfolio Value: $1,000,000
Portfolio Beta: 1.20
Current S&P 100 (OEX) Index Value: 480
How many puts are needed to hedge this portfolio?
25 puts are needed to hedge this portfolio
Puts = $1,000,000 (portfolio) / [ 480 (OEX value) x 100 (contract multiplier) ] = 20.83 puts
Hedge = 20.83 puts x 1.20 (beta) = 24.97 puts
______ trade on U.S. Government debt securities, including ______, ______, and ______.
- Options
- T-Bills
- T-Notes
- T-Bonds
There are two kinds of options: ______ and ______, also known as yield-based options.
- Bond Options
2. Interest Rate Options
______ are price-based and give the option holder the right to buy or sell bonds at the strike price.
Bond Options
______ are yield-based; they are based on an underlying yield and settle in cash.
Interest-Rate Options
Bond- and yield-based options settle ______ style.
European
The underlying security in a yield option is a(n) ______.
Bond
** DEBT OPTIONS **
When interest rates go up, bond prices go down, and vice versa; therefore, for a BOND OPTION, an investor who thinks that interest rates are going higher will purchase ______ (or write ______) and an investor who thinks that interest rates are going down will purchase ______ (or write ______).
- purchase Puts
- write Calls
- purchase Calls
- write Puts
** DEBT OPTIONS **
Contract size for T-notes and T-bonds is ______; ______ bonds or notes with a(n) ______ face value.
- $100,000
- 100
- $1,000
** DEBT OPTIONS **
Contract size for T-bills is ______; ______ T-bills with ______ face value.
- $1,000,000
- 100
- $10,000
** DEBT OPTIONS **
Strike prices are a(n) ______ of face value. For example, a T-note call with a strike price of 98 means that the holder has the right to purchase 100 T-notes at 98 or ______.
- Percentage
- $98,000
** DEBT OPTIONS **
T-bond and T-note premiums are in ______, just like bonds, and points are ______. For example, if a T-note call has a premium of 2.10 the dollar value of the premium is ______.
- 32nds
- $1,000
- $2,312.50
2 + 10/32 = 2.3125 x $1,000 = $2,312.50
** DEBT OPTIONS **
T-bill points are worth ______; one point is ______ but T-bills have ______ maturities, so ______ / 4 = ______. Premiums are quoted as a(n) ______ of face value. The dollar value of T-bill option premium of 0.6 is ______.
- $2,500
- $10,000
- 13-Week
- $10,000
- $2,500
- Percentage
- $1,500
0.6 (premium) x $2,500 (point) = $1,500
** DEBT OPTIONS **
Interest rate options are based on an underlying ______.
Yield
** YIELD-BASED OPTIONS **
Interest rate options are available on ______, ______, and ______.
T-bills, T-notes, and T-bonds
** YIELD-BASED OPTIONS **
When interest rates go up, bond prices go down, and vice versa; therefore, for an INTEREST RATE OPTION, If investors think interest rates are going higher, they will buy ______ (or write ______, and if they think interest rates are going lower they will buy ______ (or write ______).
- buy Calls
- write Puts
- buy Puts
- write Calls
** YIELD-BASED OPTIONS **
Exercise settlement is in ______; the option holder receives ______ equal to the intrinsic value of the option.
Cash
** YIELD-BASED OPTIONS **
The underlying value is the interest rate multiplied by ______. For example, the underlying value on an option with a 5.5% yield is ______.
- 10
- $55.00
5.5% x 10 = 55
Strike prices are based on ______; so a 55 strike price equals ______ yield.
- Interest Rates
2. 5.5%
Interest rate premiums are multiplied by ______. For example, TNX 45.00 call @ $3. The total premium is ______.
- 100
- $300
$3 (premium) x 100 = $300
At expiration, if interest rates are 5.5%, the holder of TNX 45.00 call would exercise and receive the intrinsic value of ______.
$10
Underlying Value: 5.5% x 10 = $55
Strike Price: $45
$55 (value) - $45 (call) = $10
Investors can use ______ to speculate on the direction of interest rates and to hedge a bond portfolio against a rise in interest rates.
Interest Rate Options
Investors could also write bond or interest rate options to increase the ______ on their portfolio.
Yield
______ are options on foreign currencies.
World Currency Options
A currency option is never on the ______; the option is always on the ______ currency.
- U.S. Dollar
2. Foreign
Foreign currency options are quoted in ______.
U.S. Cents
Though you are always better on the foreign currency, the ______ and ______ are expressed in U.S. dollars.
- Strike Price
2. Premium
Foreign currency options normally trade on the ______. Trading hours for foreign currency options run from ______ to ______ Eastern.
- Philadelphia Stock Exchange
2. 9:30 A.M. to 4:00 P.M.
The same option fundamentals apply to all options, regardless of the underlying asset. With world currency options, a long call is still ______ and a long put is still ______. The only thing different is the underlined security. Instead of an equity or index, the underlying asset is a(n) ______.
- Bullish
- Bearish
- Foreign Currency
The term for current market value of the foreign currency is _______.
Spot Price
Foreign currency options normally have a contract size of ______, so one contract represents ______ units of that foreign currency.
One exception is Japanese yen. A yen represents ______ per contract.
- 10,000
- 10,000
- 1 million
World currency options exercise ______, meaning they can only be exercised on the expiration date.
European-Style
There are also limits of the number of world currency contracts an investor may hold on the same side of the market - ______ side or ______ side. Position limits for an individual (or an individual acting in concert) are ______ contracts on the same side of the market.
- Bullish
- Bearish
- 200,000
Remember that ______ and ______ options are both bullish. ______ and ______ are both bearish.
- Long Calls
- Short Puts
- Short Calls
- Long Puts
Foreign currencies go in the ______ direction of the U.S. dollar. So if you follow the U.S. dollar, and the dollar is declining against the foreign currency, you are ______ on the foreign currency. Conversely, if you expect the dollar to strength, you are ______ on the foreign currency.
- Opposite
- Bullish
- Bearish
A memory trick to assist in answering foreign currency test questions is to remember EPIC, which means ______.
Exporters buy
Puts
Importers buy
Calls
