Equity Options Flashcards
Options contracts can be “in-the-money,” “at-the-money,” or “out-of-the-money.” Of the following, which is “in-the-money”?
[A] A put contract with a strike price that is lower than the market price of the underlying common stock.
[B] A put contract with a strike price that is equal to the market price of the underlying common stock.
[C] A call contract with a strike price that is higher than the market price of the underlying common stock.
[D] A call contract with a strike price that is lower than the market price of the underlying common stock.
[D] A call contract with a strike price that is lower than the market price of the underlying common stock.
A call contract is “in-the-money” when the strike price on the contract is lower than the current market price. Another way of saying this is that a call is “in-the-money” when the market price exceeds the strike price on the contract. A put contract is “in-the-money” when the strike price on the contract is higher than the current market price. Another way of saying this is that the put is “in-the-money” when the market price is lower than the strike price on the contract.
A customer writes 10 ABC May 40 calls @ 4.75 when the market price of ABC is $42 per share. What is the customer’s maximum gain potential?
[A] $4,750
[B] $40,000
[C] $42,000
[D] Unlimited
[A] $4,750
The customer’s maximum gain potential in this question would be the premium income of $4,750.
With no other positions in her account, a customer buys 100 shares of XYZ at $45/share and simultaneously buys 1 XYZ Jan 45 put for a premium of 3. The customer will breakeven if, at the expiration, the market price of XYZ is:
[A] $48
[B] $45
[C] $42
[D] $40
[A] $48
B - 4500
B - 300
= -4800/100
$48/share
Which statement is false regarding a listed option?
[A] It is a wasting asset.
[B] It has a variable strike price until expiration.
[C] If it is out-of-the-money, it has no intrinsic value.
[D] It belongs to one of two classes of options (Calls or Puts).
[B] It has a variable strike price until expiration.
A listed option’s strike price is set once the option is issued and does not change. It is not variable. All of the other answer choices are true of listed options.
An investor has a large portfolio of Blue Chip common stocks and expects the market to remain stable or decline slightly. He’d like to increase the rate of return on his portfolio. Which of the following would be the best choice for this investor?
[A] Buy Calls on the portfolio
[B] Write Covered Calls on the portfolio
[C] Establish a Call Spread
[D] Write Covered Puts on the portfolio
[B] Write Covered Calls on the portfolio
Covered Call writing would be the best choice for the investor, who wants to increase their rate of return on large portfolio of Blue Chip Stocks when they expect the market to remain neutral or decline slightly in value.
Which option is in-the-money?
[A] A put contract with a strike price that is higher than the market price of the underlying common stock.
[B] A put contract with a strike price that is lower than the market price of the underlying common stock.
[C] A call contract with a strike price that is higher than the market price of the underlying common stock
[D] A call contract with a strike price that is equal to the market price of the underlying common stock.
[A] A put contract with a strike price that is higher than the market price of the underlying common stock.
A put contract is “in-the-money” when the strike price on the contract is higher than the current market price. Another way of saying this is that the put is “in-the-money” when the market price is lower than the strike price on the contract. A call contract is “in-the-money” when the strike price on the contract is lower than the current market price. Again, another way of saying this is that the call is “in-the-money” when the market price exceeds the strike price on the contract.
Your customer is short WLC calls. Under the Exchange’s position limit rule, his short call position is affected by holding which of the following in his account?
[A] Long WLC calls
[B] Long WLC puts
[C] Short WLC puts
[D] Long WLC common stock
[B] Long WLC puts
Under the exchanges position limit rules, option positions are affected by options which are on the same side of the market:
Long Calls & Short Puts are on the same side of the market
Long Puts & Short Calls are on the same side of the market
With regard to Stock Index Options, which two of the following are true of the seller of a call option?
I. The maximum gain is limited to the premium.
II. The maximum gain is unlimited.
III. The maximum loss is unlimited.
IV. The maximum loss is limited to the premium.
[A] I and III
[B] II and IV
[C] II and III
[D] I and IV
[A] I and III
I is correct because the most you can make when you sell an option is the premium received. II is incorrect. III is correct because when an investor writes an index option it is uncovered; therefore uncovered calls have unlimited loss potential. IV is incorrect.
All of the following are correct concerning customer background and financial information according to option exchange rules, EXCEPT:
[A] Financial information which the customer supplies must be verified by the broker-dealer within 15 days after the account has been approved for options transactions.
[B] If the firm becomes aware of material changes concerning existing customers, a copy of background and financial information on file must be sent to the customer within 15 days after the firm becomes aware of the change.
[C] Customer background and financial information must be sent to the customer by the firm for verification within 15 days after the account is approved for options transactions unless it is contained in the customer’s account agreement.
[D] Customer background and financial information must be returned by the customer to the firm for account purposes within 15 days of being sent and reviewed by the customer.
[D] Customer background and financial information must be returned by the customer to the firm for account purposes within 15 days of being sent and reviewed by the customer.
Background and financial information of a customer must be verified within 15 days after the account was approved for options trading. Material changes would require additional verification within 15 days of the change. These conditions must take place unless the background and financial information were included in the customer’s account agreement. The customer does NOT need to return the information within 15 days of it being sent.
Which of the following is TRUE of an investor who is long 1 ABC July 50 Call Option decides to exercise the call?
[A] The exercise requires the investor to buy an additional ABC July 50 Call Option in their account.
[B] The investor will buy 100 shares of ABC Stock at $50 per share.
[C] The investor will sell 100 shares of ABC Stock at $50 per share.
[D] The exercise requires the investor to contact the same investor who sold the option in order to complete the transaction.
[B] The investor will buy 100 shares of ABC Stock at $50 per share.
When an investor buys a call option on common stock, they purchase the ability to buy 100 shares of the underlying stock at the exercise or strike price specified in the contract. So when the investor decides to exercise, this means that the investor who is long the option and exercises will buy 100 shares of the underlying stock at the exercise or strike price. The sale of 100 shares due to an exercise would be related to the purchase of a put option, NOT a call option. Exercising an option does not require the purchase of another option. Option contracts are standardized and are not isolated to two individuals which means that the investor will not have to contact the seller, as the OCC will assign the exercise to a seller in the market which is unlikely to be the same seller involved in the original option transaction.
A customer writes 1 ABC July 30 put for 4. The maximum loss potential to the customer is?
[A] $400
[B] $2,600
[C] $3,000
[D] $3,400
[B] $2,600
In which of the following cases is an RR prohibited from selling a call option?
[A] The RR has trading authority in a client’s account.
[B] The client owns 5% of the stock of the underlying company.
[C] The RR receives the order from a corporate client who issued the underlying stock.
[D] An investment adviser for the client, who has third party trading authority, enters the order.
[C] The RR receives the order from a corporate client who issued the underlying stock.
Call options may not be sold by the corporation that issued the underlying stock. Selling call options implies the belief that the security will not increase in market value and the issuing corporation has insider knowledge related to the financial condition of the entity. In each of the other scenarios, the RR is permitted to sell the call option.
A put has the highest value to the buyer when the underlying security is:
[A] Rising in market value
[B] Falling in market value
[C] Is substantially above the exercise price
[D] Is out-of-the-money
[B] Falling in market value
Assume a client tenders an exercise notice for a call to the OCC on Monday, June 3rd. The OCC assigns the notice to a firm on June 5th. The settlement date for the called stock is?
[A] Tuesday, June 4th
[B] Wednesday, June 5th
[C] Thursday, June 6th
[D] Monday, June 10th
[B] Wednesday, June 5th
When a call option is exercised, settlement of the stock is 2 business days from the time OCC receives the exercise notice. If the OCC receives notice on Monday, June 3rd, then 2 business days from this would be Wednesday, June 5th.
All of the following cover a call writer EXCEPT
[A] a long position in the underlying security.
[B] the deposit of an escrow receipt for the underlying security.
[C] long a call on the same security with an equal or lower exercise price than the short call.
[D] long a call on the same security with an equal or greater exercise price than the short call.
[D] long a call on the same security with an equal or greater exercise price than the short call.
The question is looking for which would not cover a call writer (all of the following except).
What do we need to be covered when we sell a call? Well to cover an exercise on the call we would have to sell stock. Therefore, we would need stock.
According to OCC regulations a short call can only be covered by: 1. being long the stock. 2. getting an escrow or depository receipt from a bank. 3. Being long a call with an equal or lower exercise price.
The coverage from the long call with a lower exercise price comes from the fact that we can buy the stock to deliver on our sold contract with an exercise of our long contract.
