Investments Lesson 8 Flashcards
One option controls __ shares?
100
Call option: right to __?
Buy
Put option right to __?
Sell
3 Reasons for Options:
Hedging
Speculation
Income
Call Options:
Buyers believe price will __?
Sellers believe price will __?
Rise
Fall or same
Put options:
Buyers believe price will __?
Sellers believe price will __?
Fall
Rise or same
Which option will provide investor with maximum gains if stock appreciates?
Buying a call
Which option will provide investor with maximum gains if stock price falls?
Buying a put
Intrinsic Value
Call: stock - strike
Put: strike - stock
Time value = premium - intrinsic value
*cannot be less than 0!
Example Exam Question:
Call option. Strike is $50. Stock is $53. Expires in 2 months. Premium is $5. What is intrinsic value of call option?
A. $2
B. $3
C. $4
D. $5
B
Example Exam Question:
Put option. Strike is $50. Stock is $40. Expires in 2 months. Premium is $13. What is intrinsic value of put option?
A. $2
B. $3
C. $10
D. -$10
C
In the Money
Call: stock > strike
Put: stock < strike
At the Money
Stock = Strike
Out of the Money
Call: stock < strike
Put: stock > strike
Example Exam Question:
Purchases 2 call options. Strike $50. Premium $3. At expiration stock is trading for $27. What is gain/loss?
A. $600 gain
B. $600 loss
C. $300 gain
D. $300 loss
B
Example Exam Question:
Purchases 3 put options. Strike $30. $1 premium. Trading at $35. At expiration, trading at $27. What is gain/loss?
A. $600 gain
B. $600 loss
C. $300 gain
D. $300 loss
A
Example Exam Question:
Sells 5 call options. Strike $20. $1 premium. Trading at $18 when sells call options. At expiration stock trading for $27. What is gain/loss?
A. $3,000 gain
B. $3,000 loss
C. $7,000 gain
D. $7,000 loss
B
Example Exam Question:
Sells 10 put options. Strike $50. $3 premium. Trading at $52 when sell put options. At expiration, stock trading for
$30. What is gain/loss?
A. $20,000 gain
B. $20,000 loss
C. $17,000 gain
D. $17,000 loss
D
Covered Call
Selling call options on currently owned stock
Appropriate if want to generate income but continue to own stock
Also appropriate if considering selling stock but want to generate additional premium & possibly get called out of stock
Married Put
Buying a put on currently owned
Portfolio insurance if investor owns diversified portfolio
Protecting profits or locking in gains is always __?
Buying a put
Long Straddle:
Buys put & call on same stock
Expects volatility but unsure on direction
Short straddle:
Sells put & call
Does not expect volatility, hoping to keep premiums with little to no volatility in stock price
Collar or Zero Cost Collar
Owns underlying stock but wants to protect downside risk without paying entire cost of put option
Sells call at strike slightly higher than current stock price - premium received
Then buys put below current stock price - premium used to buy put options
Black Scholes
Determine value of call
Considers: current price, time, risk free rate, volatility
All have direct relationship on price of option except strike price
Put/Call Parity
Attempts to value put based on value of corresponding call option
Binomial Pricing Model
Attempts to value option based on assumption that stock can only move in 1 of 2 directions
Can be extrapolated further based on value achieved at each interval
Call option tax consequences
- Contract lapses/expires: premium paid short term loss, premium received short term gain
- Contract exercised: premium added to basis, if less than or equal to 12 months, short term gain/loss, if more than 12 months, long term gain/loss
Put option tax consequences
If expires: short term loss premium paid, short term gain premium received
Long Term Equity Anticipation Securities (LEAPS)
Longer expiration than traditional options
2+ years
Premium higher
Warrants
Long term call options issued by corporation
Written by investors
5-10 year expiration period
Not standardized
Example Exam Question:
Call option with strike price $110 selling for $3.50 when market price is $108. Intrinsic value is:
A. $0 B. $1.50 C. $2 D. $3.50 E. -$2
A
Example Exam Question:
Purchased 100 shares at $30. Now trading at $42. Buys put with strike price of $40 for $1. How much would client make if stock trading at $35 on expiration?
A. $500 B. $600 C. $700 D. $800 E. $900
E
Example Exam Question:
Purchased 1 call option strike price $50. Premium $6. Also purchased 2 put option strike price $40. Premium $8
What is clients gain/loss if closes at $45 at expiration?
A. $2 loss/share
B. $2 gain/share
C. $6 gain/share
D. $14 loss/share
What is client’s gain/loss if close at $60?
A. $2 loss/share
B. $4 loss/share
C. $8 gain/share
D. $14 gain/share
What if close at $30?
A. $2 loss/share
B. $4 loss/share
C. $8 gain/share
D. $14 gain/share
D
B
B
Example Exam Question:
Sells call option for premium or $5. Exercise price of $50. Which is true?
A. Max gain potential is $50
B. Max loss potential is $45
C. Max gain potential unlimited
D. Max loss potential unlimited
D
Example Exam Question:
Which can cause investor to experience greatest loss?
A. Selling naked put B. Selling naked call C. Writing covered call D. Buying call E. Buying underlying security
B
Players in Futures Contact
Hedgers
Speculators
Futures are jerked to market
Gain/loss credited/debited daily
Example Exam Question:
Money fund manager concerned about decrease in British pound. What should they do?
A. Purchase futures contract on British pound
B. Buy futures contract on US dollar
C. Sell futures contract on US dollar
D. Sell futures contract on British pound
D
Lesson 8 Review:
Client expressed interest in writing/selling options. What is primary reason for taking selling position in option transaction?
A. Income
B. Hedging
C. Speculation
D. Coverage
A
Lesson 8 Review:
What are differences between options & futures?
1. Options custom designed to fit transaction
2. Futures specify price options do not
3. Options give right to do where futures buyer obligated to take delivery
4. Futures are marked to market daily options not
A. 1,2
B. 2,3
C. 3,4
D. 1,4
C
Lesson 8 Review:
Place order to sell if dip below certain price. Concern about selling significantly below purchase price if falls dramatically. With least expense to client, what position advise them to take?
A. Short sell stock owned
B. Buy put option
C. Place stop-limit order on shares
D. Sell put option
C
Lesson 8 Review:
Which is most risky?
A. Buying a call
B. Buying a put
C. Selling naked call
D. Selling naked put
C
Lesson 8 Review:
Buys call strike $50. Premium $5. Stock trading at $48. Which is true?
A. Call option in the money
B. Time premium $3
C. Time premium $5
D. Intrinsic value $2
C
Lesson 8 Review:
Buys put strike $30. Premium $5. Trading $27. Which is true?
A. Put out of money
B. Time premium $3
C. Time premium $5
D. Intrinsic value $3
D
Lesson 8 Review:
Tree farmer sells trees to lumber manufacturers. Concerned about hedging risk with price fluctuations in timber. Which do you recommend?
A. Buy futures
B. Sell futures
C. Short straddle
D. Long straddle
B
Lesson 8 Review:
5 years ago bought stock $7/share. Today trading at $100/share. Lock in profit. Which would you recommend?
A. Buy call
B. Sell call
C. Buy put
D. Sell put
C
Lesson 8 Review:
Owns stock in narrow trading range. Interested in keeping but generate income. What do you recommend?
A. Buy call out of money
B. Sell call in money
C. Sell call out of money
D. Buy call in money
C
Lesson 8 Review:
Buys call strike $50 premium $5 currently $48. At expiration $64. What is gain/loss?
A. $9 gain
B. $14 gain
C. $9 loss
D. $14 loss
A
Lesson 8 Review:
Two contractors competing for contract. Will announce winner April 18. Know company that wins stock will appreciate. Company that loses stock will go down. Which strategy should use to take advantage of price movements?
A. Long straddle
B. Short straddle
C. Covered call
D. Married put
A
