Missed Questions on Options

Question 1

What is the “time premium” amount of the following contract?

1 ABC Jan 55 Put @ $2
ABC Market Price = $61

A. $2
B. $4
C. $6
D. $8

Answer 1

The best answer is A.
This contract is “out the money,” so there is no intrinsic value currently. The total premium paid of $2 represents the “time premium” for this contract.

Question 2

A customer buys 1 ABC Jul 50 Put at $7 when the market price of ABC is $49. The breakeven point is:

A. $57
B. $56
C. $43
D. $42

Answer 2

The best answer is C.
The holder of the put paid a $7 premium per share for the right to sell ABC stock at $50. The customer’s net sale proceeds upon exercise equals $43 per share. To breakeven, he or she must buy the stock in the market at this price.

Question 3

A customer sells 2 ABC Jan 15 Puts @ 2 when the market price of ABC is $14. The breakeven point is: 
 		A. 	$11
		B. 	$13
 		C. 	$17
		D. 	$19

Answer 3

The writer of a put breaks even if the premium received is lost. 2 points in premiums were received per share. If the market falls below $15, the writer will be exercised and must buy the stock at $15 (it is “put to” he or she). The writer loses the premium received if he or she sells that stock at $13. This is the breakeven point.

Question 4

A customer sells 1 ABC Feb 45 Call @ $4 when the market price of ABC is 46. If the market value of ABC falls to $41 and stays there through February, the customer will:

A. break even
B. gain $300
C. lose $400
D. gain $400

Answer 4

The best answer is D.

If the market falls to $41, the 45 call expires “out the money” and the writer retains the $400 premium.

Question 5

A customer buys 2 ABC Jan 40 Calls @ $5 when the market price of ABC is at $39. The breakeven point is: 
 		A. 	$29
 		B. 	$30
		C. 	$45
		D. 	$50

Answer 5

The best answer is C.
The holder of a call breaks even if the market price rises by enough to recover the premium paid. The holder paid $5 for the right to buy stock at $40. The effective cost if he exercises is $45 per share. He must be able to sell the stock for $45 to breakeven. Note that breakeven is always computed on a “per share” basis. The fact that there are 2 contracts does not affect the breakeven computation.

Question 6

A customer buys 100 shares of ABC stock at $56 and buys 1 ABC Jul 55 Put @ $2.50 on the same day The breakeven point is: 
		A. 	$52.50
 		B. 	$57.50
		C. 	$58.50
 		D. 	$60.50

Answer 6

The best answer is C.
Since the customer paid $56 for the stock and paid a premium of $2.50 to buy the put, the total money outlay is $58.50. To breakeven, the stock must be sold for this price.

Question 7

On the same day in a margin account, a customer sells short 100 shares of ABC at $46 and buys 1 ABC Jan 45 Call @ $2.50. The customer will break even at: 
 		A. 	$20.50 per share
		B. 	$43.50 per share
 		C. 	$47.50 per share
		D. 	$48.50 per share

Answer 7

The best answer is B.
The customer has sold short the stock at $46, hoping to profit if the price should fall. As a hedge, the customer bought the call option to buy in the stock at a price of $45 if the market should rise. This protects the short stock position from unlimited upside loss potential. Since the customer sold the stock at $46 and paid $2.50 for the call option, the customer has a net sale amount of $43.50. To break even, the customer must buy back the stock at $43.50 per share.

Question 8

A customer buys 100 shares of ABC stock at $40 and sells 1 ABC Jan 45 Call @ $2 on the same day in a cash account. The customer's maximum potential loss is: 
 		A. 	$200
		B. 	$3,800
 		C. 	$4,500
		D. 	unlimited

Answer 8

The best answer is B.
If the stock drops, the call expires “out the money.” As the stock keeps dropping, the customer loses more and more on the stock position. Because he effectively paid $3,800 ($40 price - $2 premium collected) for the stock, this is his maximum potential loss.

Question 9

A customer sells short 100 ABC @ $35 and sells 1 ABC Jan 35 Put @ $3. The customer would NOT make money if the market price for ABC was at: 
		A. 	$30
 		B. 	$35
 		C. 	$37
		D. 	$40

Answer 9

The best answer is D.
A customer with a short stock / short put position loses if the market rises. The customer sold the stock at $35 and collected $3 in premiums, for a total of $38. To break even, the stock must be bought for this amount. If the stock is bought for more than $38, the customer loses. Therefore, a loss is experienced at $40.

Question 10

What is the maximum potential loss for a customer who is short 100 shares of ABC stock at $33 and short 1 ABC Jan 35 Put at $6? 
 		A. 	$600
 		B. 	$900
		C. 	$2,700
		D. 	unlimited

Answer 10

The best answer is D.
If the market rises, the put contract expires, but the customer is responsible for covering the short stock position. The potential loss on the remaining short stock position is unlimited, since the market can rise an unlimited amount.

Question 11

A customer buys 1 ABC Jan 40 Call @ $4 and buys 1 ABC Jan 40 Put @ $3 when the market price of ABC = $42. The breakeven points are: 
 		A. 	$36 and $43
		B. 	$37 and $44
		C. 	$33 and $47
 		D. 	$35 and $45

Answer 11

The best answer is C.
Long straddles are profitable if the market either moves up or down. To breakeven, the total premium paid must be recovered by the market moving either up or down. To breakeven, the $7 debit paid for the straddle must be gained back. This happens at 40 + 7 = $47 on the call side of the straddle and 40 - 7 = $33 on the put side of the straddle.

Question 12

A customer sells 1 ABC Jan 45 Call @ $7 and sells 1 ABC Jan 45 Put @ $3 on the same day when the market price of ABC stock is $49. Assume that the market price falls to $44 and the call premium falls to $5, while the put premium rises to $7. The customer closes the positions. The gain or loss is: 
 		A. 	$200 gain
		B. 	$200 loss
		C. 	$1,000 gain
 		D. 	$1,200 loss

Answer 12

The best answer is B.
The customer established two positions with a credit of $10 x 1 contract = $1,000 credit. When the market is at $44, the customer closes the call at $5 and closes the put at $7. Thus, the positions are closed at:
Buy 1 ABC Jan 45 Call @ $ 5
Buy 1 ABC Jan 45 Put @ $ 7
$12 debit = $1,200 debit
The customer closed for a debit of $1,200. Since the initial credit was $1,000, the customer has a $200 loss.

Question 13

A customer sells 1 ABC Jul 30 Call @ $1 and sells 1 ABC Jul 30 Put @ $3.50 when the market price of ABC is $29. The breakeven points are: 
		A. 	$26.50 and $31.00
		B. 	$25.50 and $34.50
 		C. 	$27.50 and $33.50
 		D. 	$29.00 and $35.00

Answer 13

The best answer is B.
A short straddle is the sale of a call and a put on the same stock, with the same strike price and expiration. To breakeven, the writer must lose the 4.50 point credit received for selling the straddle. If the market rises, the call side will be exercised at a loss to the writer. The call breakeven is $30 + $4.50 = $34.50. If the market falls, the put side will be exercised at a loss to the writer. The put breakeven is $30 - $4.50 = $25.50.

Question 14

On the same day, in a margin account, a customer buys 1 ABC Jan 50 Call @ $10 and sells 1 ABC Jan 60 Call @ $5. The breakeven point is: 
 		A. 	$45
		B. 	$55
		C. 	$65
 		D. 	$75

Answer 14

The best answer is B.
To breakeven, the customer must recover the $5 debit. Since this is a long call spread, the customer profits from the long call position. To breakeven, the market must rise above 50 by the 5 points paid in net premiums. Therefore, the breakeven is $50 + $5 = $55.

Question 15

A customer buys an ABC May 50 Put and sells an ABC Jun 50 Put. The customer profits if:
I The spread widens
II The spread narrows
III Both contracts expire

	A. 	I only
 		B. 	II only
	C. 	I and III
	D. 	II and III

Answer 15

The best answer is D.
The June expiration must be longer than the May expiration. The maximum life of a regular option contract is 9 months. If it is now May, then the June contract can trade (since it is 1 month later than May). However, if it is June, a May contract cannot be trading, because the following May is 11 months away. Thus, the customer is buying the near expiration (less expensive) and selling the far expiration (more expensive since there is more time left to the contract), so this must be a credit calendar spread. Credit spreads are profitable if the spread between the premiums narrows. If both contracts expire, the credit is the profit. If both contracts are exercised, the customer buys the stock at 50 and sells it at 50, still keeping the credit.

Question 16

On the same day in a margin account, a customer buys 5 ABC January 40 Calls @ $6 and sells 10 ABC January 50 Calls @ $1 when the market price of ABC is at $43. If the market moves to $48 and the contracts are closed at intrinsic value, the gain or loss is: 
		A. 	$2,000 gain
 		B. 	$2,000 loss
		C. 	$2,500 gain
 		D. 	$2,500 loss

Answer 16

The best answer is A.
If the market moves to $48, and the contracts are closed at intrinsic value, the short 50 calls expire since they are “out the money.” On the long 40 calls, the customer will have a gain of 8 points per contract. Thus, the customer will gain $800 per long call x 5 contracts = $4,000. Since the customer paid a true net debit of $400 per contract (5 points per spread - 1 point received on each of the naked calls) x 5 contracts = $2,000 paid, the net profit is $2,000.

Question 17

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 17

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 18

Which of the following is a settlement type for foreign currency trading?
 		A. 	Cash
		B. 	Regular Way
		C. 	Forward
 		D. 	Future

Answer 18

The best answer is C.
Trades of foreign currencies settle either “spot” (1 or 2 business day settlement - the more actively traded currencies settle in 1 day; less actively traded currencies settle in 2 days) or forward (a mutually agreed date in the future). Do not confuse this with trades of foreign currency options. Trades of foreign currency options settle either cash (same day) or regular way (next business day).

Question 19

To liquidate a short call position, an order ticket must be marked: 
 		A. 	opening purchase
		B. 	opening sale
		C. 	closing purchase
 		D. 	closing sale

Answer 19

The best answer is C.
To establish a short option (call or put) position, the order ticket must be marked “opening sale.” To liquidate this position, the order ticket is marked “closing purchase.”