options Flashcards
The maximum gain for the holder of a call is:
A. the premium paid
B. unlimited
C. strike price minus premium paid
D. strike price plus premium paid
The best answer is B. The maximum gain for the holder of a call is unlimited, since the holder can exercise and buy the stock at a fixed price - no matter how high the market price of the stock rises. If the market price falls below the strike price, then the call expires “out the money” and the maximum loss is the premium. To breakeven, the premium paid must be recovered in a rising market. This occurs if the market price rises to the strike price plus the premium paid.
Which statements are true when comparing horizontal and vertical spreads?
- a horizontal apread is a time spread
- a horizontal spread is a price spread
- a vertical spread is a time spread
- a vertical spread is a price spread
A. 1 and 3
B. 1 and 4
C. 2 and 3
D. 2 and 4
The best answer is B. A vertical (or “price”) spread is so-called, because the strike prices are different. When the positions are “stacked” vertically, one strike price is higher than the other. For example:
Buy 1 ABC Jan 50 Call
Sell 1 ABC Jan 60 Call
This is a vertical spread - the expirations are the same; but 1 strike price is higher than the other (“vertical to the other”).
A horizontal spread is so-called, because the expirations are different (if looked at on a time line, one is horizontal to each other). When the positions are “stacked,” the strike prices are the same, but the expirations are different. For example:
Buy 1 ABC Jan 50 Call
Sell 1 ABC Mar 50 Call
This is a horizontal, or calendar or time, spread - the expirations are different; but the strike prices are the same.
A customer sells 1 ABC Jul 40 put at $6 when the market price of ABC is $38. The customer’s maximum potential gain is:
A. $600
B. $3,400
C. $4,000
D. Unlimited
The best answer is A. The maximum gain for the writer of a naked call or put is the premium collected. This happens if the contract expires “out the money.”
A customer sells 1 ABC Jul 55 Call @ $6.50 and sells 1 ABC Jul 55 Put @ $1 when the market price of ABC is $57. The maximum potential loss is: A. $650 B. $700 C.$5,500 D. unlimited
The best answer is D. Since one side of a short straddle is a short naked call, if the market rises there is unlimited risk.
A customer buys 1 OEX Jan 250 call @ $5 when the index closes at 251. The maximum potential gain is:
A. $250
B. $255
C. $500
D. Unlimited
The best answer is D. The maximum potential gain for the holder of any call option is unlimited.
A customer sells short 100 shares of DEF stock at $63 and sells 1 DEF Oct 60 Put @ $6. The market rises to $68 and the put expires. The customer buys the stock in the market covering her short stock position. The gain or loss is:
A. $100 gain
B. $100 loss
C. $300 gain
D. $300 loss
The best answer is A. If the market rises, the short put expires. Here, the customer buys the stock at $68 to cover her short stock position that was originally sold at $63. There is a 5 point or $500 loss, that is offset by the $600 in premiums received. Thus, there is a net gain of $100.
Which of the following index options would be considered “broad based”?
1 Oil and Gas Index
2 Major Market Index
3 standard and poor’s 100 index
4 standard and poor’s 500 index
A. 4 only
B. 2 and 3 only
C. 2,3 and 4
D. 1,2,3 and 4
The best answer is C. For an index option to be considered to be “Broad Based,” it must have companies in the index covering a broad spectrum of industries. Thus, the Major Market Index, and the Standard and Poor’s 100 and 500 Indexes, are all broad based. Examples of narrow indexes are oil and gas; gold; and airline stock indexes; as well as country indexes, such as the Mexico and Japan indexes.
All of the following are broad based index option contracts EXCEPT:
A. Major Market Index
B. Standard and Poor’s 100 Index
C. Value Line Index
D. Japan Index
The best answer is D. A narrow based index option is either country specific or industry specific. Broad based index options cover a variety of companies in many different industries. The Japan index option is narrow based; the Major Market index option, Standard and Poor’s 100 index option, and Value Line index option, are all broad based.
A customer buys 1 XMI Feb 350 Put @ $6 when XMI closes at 346. The time value in the premium is:
A. 1 point
B. 2 points
C. 3 points
D. 4 points
The best answer is B. Since the put contract allows the holder to sell XMI at 350 when XMI is worth 346, the contract is “in the money” by 4 points. Remember, puts go “in the money” when the market drops. Of the total 6 point premium, 4 points are “intrinsic value.” The balance of the premium (2 points) is “time premium.”
A customer who buys a “put spread” believes that the market will:
A. rise
B. fall
C. remain neutral
D. be volatile
The best answer is B. A purchase of a “put spread” is similar to simply buying a put. The difference is that a long put gives ever increasing gain potential as the market falls - all the way to “0;” a long put spread gives limited downside gain potential (for a lower premium paid).
A customer buys 100 shares of ABC stock at $48 and buys 1 ABC Jan 50 Put @ $5. The breakeven point is:
A. $43
B. $53
C. $55
D. $60
The best answer is B. The customer paid $48 for the stock and $5 for the put, for a total outlay of $53. To breakeven, the stock must be sold for $53. To summarize, the formula for breakeven for a long stock / long put position is:
long stock/longput breakeven= stock cost + premium
Which of the following create a straddle? I Short 1 ABC Jan 50 Call Short 1 ABC Jan 50 Put II Short 1 ABC Apr 50 Call Short 1 ABC Oct 50 Put III Short 1 ABC Jan 50 Call Long 1 ABC Jan 50 Put IV Long 1 ABC Jan 50 Call Long 1 ABC Jan 60 Put
A. 1 only
B. 1 and 3
C. 2 and 4
D. 3 and 4
The best answer is A. A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.
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
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.
Which of the following positions are profitable in bull markets? I Debit Call Spread II Credit Call Spread III Debit Put Spread IV Credit Put Spread
A. 1 and 3
B. 1 and 4
C. 2 and 3
D. 2 and 4
The best answer is B.
Long Calls are profitable in rising markets, as are Long (Debit) Call Spreads. In a Long Call Spread, the lower strike price call is purchased and the higher strike price call is sold. This is a debit spread because the lower strike price call being purchased is more expensive than the higher strike price call being sold. If the market rises, the long call is exercised and the stock is purchased at the lower price. If the market keeps on rising, the short call is exercised and the stock is sold at the higher price, for a profit.
Short Calls are profitable in falling markets, as are Short (Credit) Call Spreads. In a Short Call Spread, the lower strike price call is sold and the higher strike price call is purchased. This is a credit spread because the lower strike price call being sold is more expensive than the higher strike price call being purchased. If the market falls, both positions expire and the credit is kept.
Long Puts are profitable in falling markets, as are Long (Debit) Put Spreads. In a Long Put Spread, the higher strike price put is purchased and the lower strike price put is sold. This is a debit spread because the higher strike price put being purchased is more expensive than the lower strike price put being sold. If the market falls, the long put is exercised and the stock is sold at the higher price. If the market keeps on falling, the short put is exercised and the stock is bought at the lower price, for a profit.
Short Puts are profitable in rising markets, as are Short (Credit) Put Spreads. In a Short Put Spread, the higher strike price put is sold and the lower strike price put is purchased. This is a credit spread because the higher strike price put being sold is more expensive than the lower strike price put being purchased. If the market rises, both positions expire and the credit is kept.
On the same day in a margin account, a customer sells short 100 shares of ABC at $41 and buys 1 ABC Jan 45 Call @ $7. The customer will break even at:
A. $34 per share B. $38 per share C. $48 per share D. $ 52 per share
The best answer is A.
The customer has sold short the stock at $41, 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 $41 and paid $7 for the call option, the customer has a net sale amount of $34. To break even, the customer must buy back the stock at $34 per share. To summarize, the formula for breakeven for a short stock / long call position is:
short stock/long call breakeven= short sale price- premium
A customer buys 100 shares of ABC stock at $56 and buys 1 ABC Jul 55 Put @ $2.50 on the same day. The maximum potential loss is:
A. 0
B. $250
C. $350
D. unlimited
The best answer is C. If the market should fall, the customer will exercise the put and sell the stock at the strike price, limiting potential loss. The put contract gives the customer the right to sell the stock at $55. Since the stock was purchased at $56, 1 point will be lost on the stock. In addition, 2.50 points were paid in premiums for a maximum potential loss of 3.50 points or $350.
A customer writes 1 XYZ Jan 40 Put. To cover the position, the customer would:
A. buy 1 xyz jan 30 put
B. sell 1 xyz jan 30 put
C. buy 1 xyz jan 50 put
D. sell 1 xyz jan 50 put
The best answer is C. The customer has sold 1 XYZ Jan 40 Put. Thus, if the customer is exercised, he or she is obligated to buy XYZ stock at $40 per share. If the customer buys 1 XYZ Jan 50 Put, then the customer can always exercise the long put and sell that stock for $50, if it is put to him for $40. By purchasing the 50 put, the customer has created a “long put spread.” Purchasing the XYZ Jan 30 Put does not cover the customer under O.C.C. rules. If the customer is exercised on the short put, buying the stock for $40, by exercising the long 30 put, he can only sell at $30 per share, losing 10 points in the process. To be covered under O.C.C. rules, the strike price of the long put must be the same or higher than that of the short put.
Which of the following cover the sale of 1 XYZ Jul 50 Call contract?
I The deposit of 4 XYZ convertible bonds, each convertible into 25 shares of XYZ stock
II The purchase of 1 XYZ Aug 50 call
III The purchase of 1 XYZ Jun 50 call
IV The deposit of $5,000
A. 1 only
B. 1 and 2
C. 2 and 3
D 1,2,3 and 4
The best answer is B. The deposit of the XYZ convertible bonds covers the sale of the XYZ Jul 50 Call because should the call be exercised, the bonds can be converted and the stock delivered. Similarly, the purchase of 1 XYZ Aug 50 Call covers the short call. If the short call is exercised, forcing delivery, the long call can be exercised into August to get the stock. The purchase of 1 XYZ Jun 50 Call does not cover the sale of the Jul 50 Call. Assume, for example, that in July, the short call is exercised. The long call expired in June, so you must go to the market to get the stock. This position is not covered. The long call must have the same expiration or later to cover the short call. The deposit of cash will not cover the sale of a call since the potential loss is unlimited.
An investor sells short 100 shares of ABC stock at $69 and sells 1 ABC Jan 70 Put @ $5 on the same day in a margin account. The breakeven point is:
A. $64
B. $65
C. $74
D. $75
The best answer is C. Since the customer received $5 per share in premiums, he or she can afford to lose $5 on the short stock position and still break even. The stock was sold short at $69. If the market rises to $74, the customer can buy back the stock and break even. To summarize, the formula for breakeven for a short stock / short put position is:
SHORT/SHORTPUTBREAKEVEN= SHORT SALE PRICE+PREMIUM
