Equity (Stock) Options

Question 1

The Options Clearing Corporation is responsible for all of the following EXCEPT:

A. standardization of listed options contracts
B. trading of listed options contracts
C. issuance of listed options contracts
D. assignment of exercises of listed options contracts

Answer 1

The best answer is B.

The Options Clearing Corporation is the legal issuer and guarantor of listed options contracts. The O.C.C. standardizes the options contracts that it will issue to increase potential investor participation. If there is an exercise of an option contract, it is the O.C.C. who assigns the exercise notice to a writer of that contract. Trading of listed options contracts takes place on exchange floors, under the rules of the exchange. The O.C.C. does not establish options trading rules - these are established by the exchanges.

Question 2

If an opening trade of an option contract occurs on the Chicago Board Options Exchange, the issuer of the contract is the:

A. Chicago Board Options Exchange
B. Options Clearing Corporation
C. Securities Exchange Commission
D. Registered Options Trader

Answer 2

The best answer is B.

The Options Clearing Corporation (O.C.C.) is the legal issuer and guarantor of all exchange traded options. Thus, the purchaser of an option contract is relieved of the worry that a writer will not perform on an exercise - since technically, the O.C.C. is the writer of the contract. (The O.C.C. requires that member firms deposit daily monies to ensure that the firms, if their customers are writers who have been exercised, can perform on the exercise.)

Question 3

Which of the following is NOT standardized for listed option contracts?

A. Contract size
B. Expiration date
C. Strike price interval
D. Commissions and exercise Costs

Answer 3

The best answer is D.

Exchange traded option contracts have standardized contract sizes (e.g., 100 shares of stock), standardized expiration date and time (11:59 PM Eastern Standard Time on the 3rd Friday of the month), and standardized strike price intervals (generally 5 point intervals). The premium or “price” of the option is determined minute by minute in the trading market.

Any fees/commissions levied on options trades or assignments by broker-dealers are negotiable.

Question 4

The January stock option contracts of a company assigned to Cycle 3 have just expired. Which contracts will commence trading on the CBOE?

A. February
B. March
C. July
D. September

Answer 4

The best answer is D.
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The options cycles are:

Cycle 1 Jan Apr Jul Oct
Cycle 2 Feb May Aug Nov
Cycle 3 Mar Jun Sep Dec

Cycle 3 contracts are issued for the months of Mar - Jun - Sept - Dec. One can always get a contract for this month, next month, and the next 2 months in the Cycle.

In January, prior to expiration, the contracts that will trade are January (this month), February (next month), March and June (the next 2 months in the cycle).

After January contracts expire, the contracts that will trade are February (this month), March (next month), June and September (the next 2 months in the cycle).

Question 5

The November stock option contracts of a company assigned to Cycle 1 have just expired. Which contracts will commence trading on the CBOE?

A. December
B. January
C. April
D. July

Answer 5

The best answer is D.

The options cycles are:

Cycle 1 Jan Apr Jul Oct
Cycle 2 Feb May Aug Nov
Cycle 3 Mar Jun Sep Dec

Cycle 1 contracts are issued for the months of Jan - Apr - Jul - Oct. One can always get a contract for this month, next month, and the next 2 months in the Cycle.

In November, prior to expiration, the contracts that will trade are November (this month), December (next month), January and April (the next 2 months in the cycle).

After November contracts expire, the contracts that will trade are December (this month), January (next month), April and July (the next 2 months in the cycle).

Question 6

The maximum life on a regular stock option contract is:

A. 4 months
B. 8 months
C. 12 months
D. 24 months

Answer 6

The best answer is B.

The maximum life of a regular stock option contract is 8 months (this may be tested as 9 months, though). Longer term stock options, known as LEAPs (Long Term Equity Anticipation options) have a maximum life of 28 months.

Question 7

O.C.C. rules limit the maximum “legal” life of an equity option contract to:

A. 9 days
B. 9 months
C. 30 days
D. 30 months

Answer 7

The best answer is B.

Legally, the maximum life of a regular stock option contract is 9 months. Currently, the way that options are issued, the actual maximum life is 8 months. Longer term stock options, known as LEAPs (Long Term Equity Anticipation options) have a maximum life of 28 months.

Question 8

All of the following statements are true about stock options contracts EXCEPT they:

A. are American style
B. can be traded at any time
C. can be issued at any time
D. can be exercised at any time

Answer 8

The best answer is C.

The very first options contracts were single stock options, which started trading on the CBOE in 1973. All single stock options are “American Style” - these are options that can be exercised at any time. In contrast, European style options can only be exercised at expiration and not before.

All options contracts can be traded anytime until expiration. Options contracts cannot be redeemed and they can only be issued based on the cycles set by the Options Clearing Corporation.

Question 9

An American Style stock option differs from a European style stock options because it can be:

A. traded anytime until expiration
B. exercised anytime until expiration
C. issued at any time until expiration
D. redeemed anytime until expiration

Answer 9

The best answer is B.

The very first options contracts were single stock options, which started trading on the CBOE in 1973. All single stock options are “American Style” - these are options that can be exercised at any time. In contrast, European style options can only be exercised at expiration and not before.

All options contracts can be traded anytime until expiration. Options contracts cannot be redeemed and they can only be issued based on the cycles set by the Options Clearing Corporation.

Question 10

Regular way trades of all of the following securities settle next business day EXCEPT:

A. Listed stocks
B. Listed stock options
C. Treasury Bills
D. STRIPS

Answer 10

The best answer is A.

Regular way trades of U.S. Governments (STRIPS are zero coupon U.S. Government obligations) settle next business day. Regular way trades of options settle next business day. Regular way trades of listed stocks settle 2 business days after trade date.

Question 11

Regular way trades of which of the following securities settle next business day?

A. Municipal bonds
B. Listed stocks
C. Listed stock options
D. Corporate bonds

Answer 11

The best answer is C.

Regular way trades of listed options securities settle next business day (as do regular way trades of U.S. Governments). Regular way trades of stocks, corporate bonds, and municipal bonds settle 2 business days after trade date.

Question 12

The last time to trade expiring equity options is:

A. 4:00 PM Eastern Standard Time; 3:00 PM Central Time; on the day prior to expiration
B. 4:00 PM Eastern Standard Time; 3:00 PM Central Time; on the expiration day
C. 5:30 PM Eastern Standard Time; 4:30 PM Central Time; on the day prior to expiration
D. 5:30 PM Eastern Standard Time; 4:30 PM Central Time; on the expiration day

Answer 12

The best answer is B.

Listed equity options trade until 4:00 PM Eastern Standard Time on the third Friday of the expiration month. The contracts expire at 11:59 PM Eastern Standard Time, on the third Friday of the month. Note that Central Time is included in the question because both the CBOE and OCC are located in Chicago, which is on Central Time.

Question 13

Equity options contracts for a given month expire on the:

A. third Friday of the month at 4:00 PM Eastern Standard Time
B. third Friday of the month at 11:59 PM Eastern Standard Time
C. last business day of the month at 4:00 PM Eastern Standard Time
D. last business day of the month at 11:59 PM Eastern Standard Time

Answer 13

The best answer is B.

Equity options contracts for a given month expire on third Friday of the month at 11:59 PM Eastern Standard Time. The trading cut-off is 4:00 PM ET on the same day.

Question 14

Equity options for a given month expire at:

A. 4:00 PM EST on the third Friday of the month
B. 4:00 PM EST on the Saturday following the third Friday of the month
C. 11:59 PM EST on the third Friday of the month
D. 11:59 PM EST on the Saturday following the third Friday of the month

Answer 14

The best answer is C.

Listed equity options trade until 4:00 PM Eastern Standard Time (EST) on the third Friday of the expiration month. The contracts expire at 11:59 PM Eastern Standard Time that same day - the third Friday of the month.

Question 15

An exercise of a listed stock option settles:

A. the same day
B. the next business day
C. in 2 business days
D. in 5 business days

Answer 15

The best answer is C.

If a customer exercises a call contract, the customer is buying the stock in a regular way trade (the exercise date is considered to be the trade date). The customer must pay the strike price to the writer on settlement. If a customer exercises a put contract, the customer is selling the stock in a regular way trade (the exercise date is considered to be the trade date). The customer must pay the strike price to the call writer; or deliver the stock to the put writer; on settlement. Regular way settlement of stock trades occurs 2 business days after trade (exercise) date.

Question 16

To receive a dividend, the holder of a call contract may exercise the contract on all of the following days EXCEPT:

A. two business days prior to record date
B. two business days prior to ex date
C. one business day prior to record date
D. one business day prior to ex date

Answer 16

The best answer is C.

To receive a dividend, the holder of a call contract must exercise the contract prior to the ex date. Settlement of exercise takes place in 2 business days.

In Choice A, if the customer exercises 2 business days prior to record date, the holder would be entitled to the dividend since the trade settles on the Record Date (the date that the list of holders of record are taken to be sent the dividend).

In Choice B, if exercise occurs two business days prior to ex date, the trade settles on the ex date. Since the ex date is 1 business day prior to the Record Date, the customer has settled in time to receive the distribution.

In Choice C, if the customer exercises one business day prior to Record Date, the trade settles on the business day following the Record Date and the customer will not receive the dividend.

In Choice D, the customer has effected the trade on the last day possible to receive the dividend - which is the business day prior to the ex date. This is 2 business days prior to the Record Date (the ex date is 1 business day prior to Record Date), so the trade will settle on the Record Date and the customer will receive the dividend.

Question 17

In order to receive a dividend distribution, the last time for the holder of a call option to exercise is:

A. at least 2 business days prior to the ex date
B. just prior to the ex date
C. just prior to the record date
D. just after the ex date

Answer 17

The best answer is B.

Exercise of an option results in a regular way trade. Stocks settle regular way 2 business days after trade date. Since the ex date is set at 1 business day prior to the record date, to receive the dividend, the stock must be bought 2 business days prior to the record date (or just prior to the ex date). Exercising the call just prior to the ex date is the same as buying the stock just prior to the ex date.

Question 18

A customer is long 10 ABC Jan 60 Call contracts. ABC Corporation has just declared a $1 per share dividend. To receive the dividend, the customer must:

A. sell the contracts prior to the ex date
B. sell the contracts prior to the record date
C. file an effective exercise notice with the Options Clearing Corporation prior to the ex date
D. file an effective exercise notice with the Options Clearing Corporation after the ex date

Answer 18

The best answer is C.

To receive a dividend, the holder of a call contract must exercise the contract prior to the ex date. Since settlement of exercise takes place in 2 business days, the customer will have settled the exercise on, or before, the record date, and will receive the dividend.

Question 19

A customer owns an ABC Call option. ABC declares a dividend for shareholders on record July 10th. The last day to exercise the option and get the dividend is:

A. July 5th
B. July 8th
C. July 9th
D. July 10th

Answer 19

The best answer is B.

If an option is exercised, a regular way stock trade results (2 business day settlement). To be an owner of record, the call must be exercised 2 business days prior to July 10th, which is July 8th. Notice that to get the dividend, the call must be exercised just prior to the ex date, (which is the business day before the record date, so in the case the ex date is July 9th).

Question 20

A customer owns 100 shares of ABC stock and owns 1 ABC Put option. The customer wishes to sell the stock by exercising the put, but wishes to retain a recently declared cash dividend. In order to receive the dividend, the customer must exercise the put:

A. before the ex date
B. on the ex date or after
C. before the record date
D. on the record date or after

Answer 20

The best answer is B.

Because exercise settlement of listed stock options occurs 2 business days after trade date, in order to retain the cash dividend, the holder of the shares cannot sell them before the ex date (which is 1 business day prior to record date). If the put is exercised on the ex date or later, the trade will settle after the record date, and the customer will be on record to receive the cash dividend.

On the other hand, if the long put were exercised before the ex date, the trade would settle on the record date or before, and the customer would be selling the stock, taking him- or herself off the record book on the record date or before, so that client would not receive the dividend.

Question 21

A customer owns 100 shares of ABC stock and owns 1 ABC Put option. The customer wishes to sell the stock by exercising the put, but wishes to retain a recently declared cash dividend. In order to receive the dividend, the customer could NOT exercise the put:

A. before the ex date
B. on the ex date or after
C. before the record date
D. on the record date or after

Answer 21

The best answer is A.

Because exercise settlement of listed stock options occurs 2 business days after trade date, in order to retain the cash dividend, the holder of the shares cannot sell them before the ex date (which is 1 business day prior to record date). If the put is exercised on the ex date or later, the trade will settle after the record date, and the customer will be on record to receive the cash dividend.

On the other hand, if the long put were exercised before the ex date, the trade would settle on the record date or before, and the customer would be selling the stock, taking him- or herself off the record book on the record date or before, so that client would not receive the dividend.

Question 22

A customer owns 100 shares of ABC stock and owns 1 ABC Put option. The customer wishes to sell the stock by exercising the put, but wishes to retain a recently declared cash dividend. In order to receive the dividend, the customer must exercise the put:

A. on the ex date
B. on the record date
C. before the ex date
D. before the record date

Answer 22

The best answer is A.

Because exercise settlement of listed stock options occurs 2 business days after trade date, in order to retain the cash dividend, the holder of the shares cannot sell them before the ex date (which is 1 business day prior to record date). If the put is exercised on the ex date or later, the trade will settle after the record date, and the customer will be on record to receive the cash dividend.

On the other hand, if the long put were exercised before the ex date, the trade would settle on the record date or before, and the customer would be selling the stock, taking him- or herself off the record book on the record date or before, so that client would not receive the dividend.

Question 23

Which statement is TRUE about index option contracts?

A. They are custom OTC contracts where the terms are negotiated between buyer and seller
B. They are available in either American or European style
C. Exercise settlement is in cash
D. Trade settlement is the same day

Answer 23

The best answer is C.

Index option contracts, such as the SPX (Standard and Poor’s 500 Index Option) allow an investor to bet on broader market movements, as opposed to individual stock price movements. They are standardized options contracts that are exchange traded.

They are also useful to institutions that wish to hedge their portfolios, or that wish to generate extra income against their portfolios. They are more “potent” than individual stock options, because the value of the S&P 500 Index is so high (around 2,700), so in theory 1 contract covers 100 x 2,700 = $270,000 worth of stock. So, in theory, for an institution that wishes to hedge a portfolio, fewer contracts need to be purchased (lower cost hedging).

Unlike stock options, index options are generally issued European style (exercise can only occur at expiration, not before). Exercise settlement is in cash, unlike stock options where exercise settlement results in a delivery of stock.

Like stock options, index options can be traded anytime, and trade settlement is next business day for both.

Question 24

An inverse ETF is most similar to taking what options position(s) on the reference index?

A. Long Call
B. Short Call
C. Long Put
D. Short Put

Answer 24

The best answer is C.

An inverse ETF is unprofitable when the market rises, and profitable when the market falls. So the answer is either a Long Put or a Short Call.

Since the maximum loss in a rising market is capped to the amount invested, and the gain keeps increasing as the market falls, the best choice is a Long Put, which has a maximum loss of the premium in a rising market and ever-increasing gain as the market falls.

In contrast, with a Short Call, in a rising market there is ever-increasing loss, and in a falling market, the gain is capped to the collected premium.