Equity Options Flashcards
When referring to call options, the term “outstanding long position” means:
[A] the total number of option contracts that may be purchased or sold on any one day.
[B] an option contract that has not yet either expired or been closed out through exercise or a liquidation sale.
[C] the investor’s net position of sales over purchases.
[D] the total number of option contracts compared to the number of common shares available on the market.
[B] an option contract that has not yet either expired or been closed out through exercise or a liquidation sale.
An investor is considered “covered” in which of the following scenarios involving option contracts? The investor:
[A] sells 1 ABC Call on common stock and owns 100 shares of ABC non-convertible preferred stock.
[B] buys 100 shares of ABC common stock and buys 1 ABC Put.
[C] buys 100 shares of ABC common stock and sells 1 ABC Call.
[D] sells 1 ABC Put and buys 100 shares of ABC common stock.
[C] buys 100 shares of ABC common stock and sells 1 ABC Call.
The primary way that the seller of a call option is covered is by having 100 shares of the underlying stock on hand in their portfolio to deliver against an exercise notice if an exercise takes place. The primary way that the seller of a put option is covered is by having cash on hand that is equivalent to the amount needed to buy the stock in the event that an exercise of the put takes place. In this question, when the investor buys 100 shares of ABC and sells 1 ABC Call, the call contract would be considered covered. Options are typically tied to common stock, so a preferred stock position generally would not cover a short call. Buyers of option contracts do not need to be “covered”, because the buyers of options are in control of whether or not an exercise takes place. Long stock will not cover a short put option.
Which of the following are true of the buyer of a call option?
I. The profit potential is unlimited.
II. The maximum loss is limited.
III. The profit potential is limited.
IV. The maximum loss is unlimited.
[A] I and II
[B] I and IV
[C] II and III
[D] III and IV
[A] I and II
I is correct because your profit potential is unlimited when you buy a call since you want the market price of the stock to go up. II is correct because when you buy a call the most you can lose is the premium paid for the option.
An investor sells short 100 shares of ABC at $25 per share and simultaneously writes one ABC June 20 put at one. To break even on this position, at what price must ABC stock close on the day prior to expiration of the put.
[A] $24
[B] $25
[C] $26
[D] $27
[C] $26
S + 2500
S + 600
=2600 / 100
=26
If a put option is assigned to a writer, the premium received by the writer under Federal Income Tax purposes is
[A] considered ordinary income at the time the premium is received.
[B] considered ordinary income when the put is exercised.
[C] used to increase the tax cost of the stock purchased as a result of the exercise.
[D] used to reduce the tax cost of the stock purchased as a result of the exercise.
[D] used to reduce the tax cost of the stock purchased as a result of the exercise.
When an investor writes a put they receive a premium and they are obligated to buy the stock if the option is exercised. If the option is exercised and the customer purchases the stock, the premium received would be used to reduce the cost basis of the stock purchased.
Which of the following does NOT need to be included in a customer confirmation under option exchange rules?
[A] The contra broker and executing agent
[B] The type of option (call or put) and the underlying security
[C] The number of contracts and the premium paid
[D] The exercise price and expiration month
[A] The contra broker and executing agent
Confirmations do not need to show the contra broker or the name of the agent executing the trade.
Under the OCC’s option position limit rules, which of the following positions would be combined in order to determine if a customer’s option position is within the specified limits?
[A] Short puts and long calls
[B] Long puts and long calls
[C] Short puts and short calls
[D] Long puts and short puts
[A] Short puts and long calls
Position limit rules regulate option positions on the same side of the market. Short puts and long calls are both bullish positions. On the bearish side, long puts and short calls are on the same side of the market.
Mr. Smith purchased 1 CCD July 75 Call @ 4. The Canadian Dollar is trading at $0.74. Mr. Smith’s total premium to purchase the call, assuming a CCD contract is 10,000 units would be:
[A] $40
[B] $400
[C] $750
[D] $300
[B] $400
Which two of the following are true of Interest Rate or Yield Based options with U.S. Treasury bonds as the underlying security?
Writers of calls expect interest rates to decline.
Writers of puts expect interest rates to increase.
Writers of calls expect interest rates to increase.
Writers of puts expect interest rates to decline.
[A] I and II
[B] III and IV
[C] I and IV
[D] II and III
[A] I and II
With interest rate or yield based options even though U.S. Treasury securities are the underlying securities, the option is traded based on the direction we expect Interest Rates and Yields to move (not prices). Call writers expect interest rates to decline and Put writers expect interest rates to rise.
Yield-based or Interest Rate options are traded based on the value of which of the following underlying securities?
I. Treasury bills with 13 week maturities based on the annualized discount rate of the most recently issued 13 week T-Bills.
II. Treasury Bonds with 30 year maturities based on the yield to maturity of the most recently issued 30 year Treasury Bonds.
III. Treasury Notes with 10 year maturities based on the yield to maturity of the most recently issued 10 year Treasury Notes.
IV. Treasury Notes with 5 year maturities based on the yield to maturity of the most recently issued 5 year Treasury Notes.
[A] I and II
[B] II and III
[C] I, II, and IV
[D] All of the above
[D] All of the above
An investor who is short a call option on ABC and wants to offset the position would enter:
[A] an opening sale
[B] a closing purchase
[C] a closing sale
[D] an opening purchase
[B] a closing purchase
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
A customer buys 100 shares of XYZ at 47 in a cash account and writes 1 XYZ July 40 call at 9. How much must be deposited by the customer into the account?
[A] $1,450
[B] $2,350
[C] $3,800
[D] $4,700
[C] $3,800
B - 4700
S+ 900
=3800
A customer buys 200 shares of XYZ at $35 per share and buys 2 XYZ July 35 puts for 3 each. The customer will have a pre-tax profit at what market price for the stock?
[A] $31
[B] $35
[C] $36
[D] $39
[D] $39
B - 7000 B - 600 =7600 / 2 =3800 (Breakeven) 39/share is profit
A customer buys 1 ABC July 60 put @ 7 and sells 1 ABC July 50 put @ 2. What is the customer’s maximum loss potential?
[A] $500
[B] $5,500
[C] $6,000
[D] Unlimited
[A] $500
B - 700
S + 200
=500
Those of the following which apply to a discretionary options accounts are:
I. There must be frequent supervisory review of the account.
II. Prior written authorization must be obtained from the client.
III. Order tickets must be identified as discretionary when they are entered.
IV. Renewal in writing must be obtained from the client.
[A] I and II
[B] I, II, and III
[C] I, II, and IV
[D] I, II, III, and IV
[B] I, II, and III
Discretionary accounts require prior written authorization from the customer before discretionary trades can be made. There must be more frequent review than regular accounts, and all discretionary trades must be designated as such on the order ticket.
Option writers usually sell puts because they
[A] own that particular stock.
[B] hope to obtain a long-term gain.
[C] have a bullish outlook for the stock.
[D] have a bearish outlook for the stock.
[C] have a bullish outlook for the stock.
A customer purchases one ABC June 60 put @ 6 and sells one ABC June 50 put at 1. What is the maximum loss on the spread?
[A] $300
[B] $500
[C] $600
[D] $700
[B] $500
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.
Of the options transactions listed below, which one is required to indicate whether the position is “covered” or “uncovered?”
[A] Opening Purchase
[B] Closing Sale
[C] Opening Sale
[D] Closing Purchase
[C] Opening Sale
When an investor becomes the writer of an option (“Opening Sale”), they must indicate on the sell ticket whether they are covered or uncovered.
A registered representative (RR) could sell uncovered call options in all of the following cases, EXCEPT:
[A] To an account that has been established for a small child’s college education
[B] To a margin account where the account is “restricted”
[C] To a corporate account when the call options are for a separate company
[D] To a joint account involving two people, one of whom is not well-versed in options trading
[A] To an account that has been established for a small child’s college education
Uncovered call options may not be sold to custodial accounts, such as those set up for a small child’s college education. Calls are not permitted to be sold to a corporate account when the calls are those tied to the company’s securities, but an RR can sell calls on the stocks of separate companies. Restricted margin accounts can participate in uncovered call writing, and if the joint account is approved for uncovered options trading, the fact that one party may not be well-versed in options trading is not a disqualifying factor.
Mr. Smith decides to establish the following option postions
Long 1 ABC Jun 100 Put @ 7
Short 1 ABC June 90 Put @3
This position would be BEST described as which two of the following?
I. Credit Spread
II. Debit Spread
III. Bullish
IV. Bearish
[A] I & III
[B] I & IV
[C] II & III
[D] II & IV
[D] II & IV
Since the difference between the premiums results in a net minus it would be a debit and since we have a buy and a sell on the same type of option on the same stock it is a spread. It would be a bearish spread because the option that he bought has a higher strike price than the one he sold (Bear - buy high) .
An investor buys 100 shares of ABC common stock at 25. If the investor later buys a put on ABC, he/she has:
[A] Created a ratio position
[B] Limited his/her future gain on ABC
[C] Hedged against a price decline
[D] Established a covered put position
[C] Hedged against a price decline
A hedge is a security transaction that reduces the risk on an already existing investment position. Buying a put offsets the potential losses from a long stock position.
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.
Stock Index options normally expire
[A] Weekly
[B] Monthly
[C] Quarterly
[D] Annually
[B] Monthly
Which of the following securities transactions would NOT be permitted in a customer’s cash account?
[A] A customer enters an order to sell a block of preferred stock that the customer currently holds long in the account.
[B] A customer enters an order to sell short a block of common stock that the customer currently does not hold long in the account.
[C] A customer enters an order to sell a covered put option in the account.
[D] A customer enters an order to sell a block of municipal bonds that the customer currently holds long in the account.
[B] A customer enters an order to sell short a block of common stock that the customer currently does not hold long in the account.
Short sales are NOT permitted in cash accounts. The customer would need a margin account in order to sell stock short. Though options trading is often limited in cash accounts, covered transactions are normally permitted. Selling securities that are currently held long in the cash account would be permitted.
An investor who buys a call:
[A] has the right to sell 100 shares of the underlying stock.
[B] has the right to buy 100 shares of the underlying stock.
[C] has the obligation to sell 100 shares of the underlying stock.
[D] has the obligation to buy 100 shares of the underlying stock.
[B] has the right to buy 100 shares of the underlying stock.
Investors who buy calls have the right to buy (call away) 100 shares of the underlying stock. Sellers of options are obligated to perform in the event that the buyer of the option decides to exercise. The right to sell 100 shares of the underlying stock is given by purchasing a put option.
A customer buys 100 shares of XYZ stock for $30 a share, and sells 1 XYZ March 35 call @ 2. What is the maximum loss the customer could sustain?
[A] $2,800
[B] $3,000
[C] $3,200
[D] $3,500
[A] $2,800
A customer purchases 1 ABC April 60 put for 8 and sells 1 ABC April 50 put for 1, when ABC stock is selling at $55 per share. What is the maximum profit the customer could realize?
[A] $300
[B] $700
[C] $1,000
[D] $1,300
[A] $300
On a spread position, the maximum profit potential is the difference between the strike prices minus the net premium paid.
Difference in Strikes (60 - 50 = 10) x Shares Per Contract (100) = $1,000 - Net Premium Paid (700) = $300 Maximum Profit Potential
An investor would have the greatest upside risk potential with which of the following option positions? [A] A call spread performed at a credit [B] A put spread performed at a debit [C] A short straddle [D] A long straddle
[C] A short straddle
“Upside Risk” means we are at risk to lose money if the market goes up. In a short straddle we always assume that the short call is “uncovered.” An uncovered call has unlimited risk potential. Therefore, if investors have a position of an uncovered short call, they have unlimited upside risk. This is because they do not own the stock that they have obligated themselves to sell, so they would have to go out into the market to buy the stock at its current market price if the option is exercised.
One of your clients that is a frequent options trader buys 100 shares of ABC common stock @ 45 and buys 1 ABC July 50 Put @ 4. Later the client decides to exercise the put and deliver the long stock position against the exercise. Upon completion of these transactions, for federal tax purposes the customer would have a
[A] $100 profit
[B] $100 in losses
[C] $900 profit
[D] $900 in losses
[A] $100 profit
A corporation that has agreed to accept payments in Euro Currency would hedge by which of the following option positions?
[A] Buying puts on the American dollar
[B] Buying calls on the American dollar
[C] Buying puts on the Euro Currency
[D] Buying calls on the Euro Currency
[C] Buying puts on the Euro Currency
Since the corporation will be paid in Euro Currency they would want to be protected from a decline in the value of the Euro and would therefore either sell calls or buy puts on the Euro.
