Practice Test 6

Question 1

A contingency order is one that contains an indication of price, time or both.

a. True
b. False

Answer 1

a. True
Contingency orders will indicate a price level, as in a stop order. They may also indicate a timing aspect, such as an “at the opening” order. They may also indicate both price and time issues, such as a “limit or market on close” order.

Question 2

Put-call parity is determined by comparing the premiums of options with different expiration months.

a. True
b. False

Answer 2

b. False
Put-call parity compares the premiums of puts to calls as a means of uncovering arbitrage opportunity. If put and call futures contracts have the same expiration period and may only be exercised on the last trading day of the contract (European style exercise), they should have the same time value if both options are in-the-money by the same amount. For example: if our strike prices were 55 for a put, and 50 for a call when the market is 52.50, both options are in the money by 2.50 points. If the premium for the call is 4, we would assume a premium of 4 for the put, since both options should have the same time value. If the put premium is less than 4, an arbitrage opportunity exists since the premium is undervalued relative to the call.

Question 3

Options are useful to futures speculators because options premiums change point-for-point with the value of the underlying futures contract.

a. True
b. False

Answer 3

b. False
The answer is false. Option premiums do not necessarily move point for point according to movements in the underlying futures contract. The measurement of the option premium movement is its delta. A delta of .80 would indicate an 80% movement in premium against the futures. Delta changes as options on futures become further in or out-of-the money.

Question 4

An investor believes the S&P 500 December contract is overvalued at 945.00 and therefore sells 15 contracts. The market rises to 950. The investor is still convinced his analysis is correct and sells an additional 20 contracts at that price. When the contract drops to 947.70, the investor closes out all 35 contracts. Assume the multiplier is $250 and roundturn commissions are $30 per contact. What is the investor’s gain or loss?

a. $10,575 loss
b. $10,900 gain
c. $325 gain
d. $1,875 gain

Answer 4

c. $325 gain
This question involves two separate speculation calculations:

Short @ 945.00
Buy @ 947.70
Loss (2.70)
Multiplier x 250
Loss (675)
Commissions (30)
Net loss/contract (705)
Contracts x 15
Total loss (10,575)

Short @ 950.00
Buy @ 947.70
Gain 2.30
Multiplier x 250
Gain 575
Commissions (30)
Net gain/contract 545
Contracts x 20
Total gain 10,900
Net gain = $325

Question 5

In which of the following situations would the basis strengthen (Assume a normal market.)

a. Cash price is stable and futures prices rise
b. Cash rises, futures rise less
c. Cash falls, futures fall less
d. Futures prices are stable and the cash price falls

Answer 5

b. Cash rises, futures rise less
In a strengthening basis, the cash commodity will increase in comparison to the futures contract. If the commodity rose by .5, while the futures rose by .3, the basis has strengthened. Similarly, if the cash commodity fell by .3, while the futures fell by .5, the basis has also strengthened.

Question 6

A customer assumes a short position at 14.50 and the contract falls to 11.20. The investor wants to protect the profits. You would recommend placing a buy stop at:

a. 13.80
b. 12.80
c. 11.00
d. 10.20

Answer 6

b. 12.80
To protect the profit, the customer will buy futures to cover the short position. They would place a stop order to protect their profit in the event that the market began to rise above its present value (11.20). Two choices are given which are above the current market price. Choice (b) (12.80) represents a more effective means to protect the profit. Choice (a) (13.80), although by no means incorrect, is not the best answer to the question, since an additional point of profit will have been eroded by the time this order is activated.

Question 7

A mortgage banker has an $11.75 million portfolio of mortgages that will be sold later in the secondary market. How many ($100,000) T-note contacts would be used to hedge the portfolio and what would be the circumstances?

a. 118 contracts to protect against rising interest rates
b. 12 contracts to protect against rising interest rates
c. 118 contracts to protect against falling interest rates
d. 12 contracts to protect against falling interest rates

Answer 7

a. 118 contracts to protect against rising interest rates
To determine the number of contracts needed to hedge the portfolio, the value of the portfolio is divided by the value of one T-note futures contract. $11,750,000 divided by $100,000 equals 117.5 contracts. In most cases the hedger should round down to avoid having a partial speculative position. Rounding down to 117 contracts is not one of the given choices. Rounding down below 117.5 to 12 contracts (the next lowest choice) is not an effective hedge for the size of the portfolio. The only viable alternative is to round up to 118 contracts. The mortgage banker is concerned that interest rates will rise causing his portfolio to fall in value.

Question 8

An economic slowdown is continuing. An investor should buy T-bond futures.

a. True
b. False

Answer 8

a. True
BLANKANSWEREXPLANATION

Question 9

A portfolio manager owns $750,000 of blue chip stocks. The manager is concerned about a downturn in the market and decides to hedge with the Major Market Index by selling 8 contracts at 440.75. (Assume the MMI multiplier is $500.) When the MMI is at 413.25, the manager closes out the futures position and liquidates the stock portfolio. The portfolio is sold for $637,500. What is the result of the hedge?

a. The futures position offsets the entire loss on the portfolio and produces an additional $2,500 profit.
b. The futures position offsets all except $2,500 of the loss on the portfolio.
c. The manager lost $110,000 on the stock portfolio and also lost $112,500 on the futures position.
d. The $110,000 gain on the stock portfolio was reduced by a $2,500 loss on the futures position.

Answer 9

b. The futures position offsets all except $2,500 of the loss on the portfolio.
The portfolio loss is based on a value of $750,000, later sold for $637,500. This results in a loss of $112,000. The hedge using the MMI results in the following:

Short @ 440.75
Buy @ 413.25
Gain 27.50
Multiplier x 500
Gain/contract 13,750
Contracts x 8
Gain 110,000
The gain of $110,000 on the futures contracts offsets all but $2,500 of the loss sustained in the portfolio.

Question 10

A short hedger is one who:

a. Buys futures contracts against a long cash position
b. Buys futures contracts against a short cash position
c. Sells futures contracts against a long cash position
d. Sells futures contacts against a short cash position

Answer 10

c. Sells futures contracts against a long cash position
A short hedger would sell futures contracts to hedge their long cash position.

Question 11

A sell stop order means execute the order immediately or not at all.

a. True
b. False

Answer 11

b. False
A stop order is triggered once the value specified in the stop is reached. It then becomes a market order to be executed as soon as possible.

Question 12

A trader buys 4 T-bills a 92.05. When the contract is at 93.04, the trader sells 3 contracts. Later, when the contract is at 93.14, the trader closes the remaining position. The result is a:

a. $5,200 profit
b. $9,900 loss
c. $10,150 profit
d. $10,900 profit

Answer 12

c. $10,150 profit
This is really two speculation questions:

A trader is long @ 92.05
They sell @ 93.04
Profit = [.99 or 99 basis points (each basis point has a value of $25.00) 99 x $25 = $2,475 profit for each of three contracts
$7,425 = total profit for the first three contracts]
In the remaining contract:

A trader is long @ 92.05
They sell @ 93.14
Profit = 1.09 or 109 basis points x $25 = $2,725

The total profit is the sum of the two profits: $7,425 + $2,725 = $10,150

Question 13

When the value of the underlying commodity is stable, as the time to expiration decreases, the value of a futures option increases.

a. True
b. False

Answer 13

b. False
In a stable market, time value erodes as the option contract approaches expiration.

Question 14

Price for corn futures are as follows.
Dec 270
Mar 266
May 261 1/4
July 252
What would most likely cause this situation?

a. A reduction in demand for corn
b. Tight supplies of corn
c. Volatile trading in the pits
d. Favorable weather forecasts

Answer 14

b. Tight supplies of corn
This is an example of an inverted market or backwardation. When near month contract prices are higher than the deferred month contract prices, this is usually due to a shortage of the underlying commodity.

Question 15

Equity in a customer’s account drops below maintenance level. Which of the following is true?

a. The client must deposit cash to bring the equity up to the original margin requirement.
b. The client must deposit cash to bring the equity up to the maintenance level.
c. The broker must demand additional cash only if the client takes a new position.
d. The broker must immediately close the position.

Answer 15

a. The client must deposit cash to bring the equity up to the original margin requirement.
In the futures market, a maintenance call (variation call) requires the client to deposit an amount sufficient to bring equity to the original margin requirement level.

Question 16

The manager of a large equity portfolio is considering writing a covered call. When the market value of the S&P 500 is 899, there are 898 puts and calls both available with a premium of $4. If the S&P 500 is below 898 at expiration, the manager would:

a. Gain $4 from selling a call
b. Lose $4 on the portfolio
c. Gain $4 from selling a put
d. Lose $4 from buying a call

Answer 16

**a. Gain $4 from selling a call** 
 The writer (seller) of a call option receives the option premium. In this case, the call option would expire unexercised, since the market price is below the strike price of the call.

Question 17

An arbitrageur believes the December S&P 500 contract has a theoretical value of 809. The actual current price of the contract is 808.40 and the initial margin requirement is $15,000 per contract. The arbitrageur buys 10 contracts. The multiplier is $250. The December contract goes to 809 and she closes out her position. What is the gain in dollars and as a percentage of the margin?

a. $150 profit and .01
b. $150 profit and .10
c. $1,500 profit and .01
d. $1,500 profit and .10

Answer 17

c. $1,500 profit and .01
The arbitrageur goes long the futures @ 808.40

The contracts are sold @ 809
The profit = .60 points
Each point has a value given as $250

The profit per contract: .60 x $250 = $150. Multiplied by the ten contracts results in a total profit of $1,500. The initial margin requirement is $15,000 per contract. The arbitrageur bought 10 contracts.

Since the profit was $150 per contract, the total profit is $150 x 10 = $1,500. The percentage profit is determined by taking the profit per contract ($150) and dividing it by the margin requirement per contract ($15,000). This equates to a .01 profit or 1%. The total profit of $1,500 can also be divided by the total margin requirement of $150,000. This results in the same 1% profit.

Question 18

There is an active OTC market in futures contracts similar to the OTC market in equities.

a. True
b. False

Answer 18

b. False
The answer is false. Trading in futures occurs on the organized exchanges. There is no active over the counter market for futures.

Question 19

Rising prices with decreasing volume is a technically strong market.

a. True
b. False

Answer 19

b. False
The two examples of a technically strong market are: rising prices and increasing volume, or declining prices and declining volume. The example given is that of a technically weak market. Declining prices and increasing volume represent the other example of a technically weak market.

Question 20

What is the reason for the leverage found in futures contracts?

a. The volatility of futures prices
b. The small margin compared to the size of the futures contract
c. The size of the minimum price change (tick)
d. The size of the contract

Answer 20

b. The small margin compared to the size of the futures contract
The required margin for a futures contract is a relatively small percentage of the underlying value in the contract. This provides the leverage. For example: if the required margin is 10% for a contract, a client would have 10 times leverage. If the required margin is 5%, the client would have 20 times leverage.

Question 21

A farmer estimates his corn crop to be 6,500 bushels. He hedges by selling one futures contract at 3.31. He later sells his cash crop at 3.18 and closes out the futures position at 3.20. What is the net amount the farmer received from his crop?

a. $16,450
b. $20,670
c. $21,220
d. $21,385

Answer 21

c. $21,220
The answer to this question requires knowledge of the futures contract size. In the case of corn, the contract size is 5,000 bushels.

The profit on the futures position is:
Short @ 3.31
Buy @ 3.20
Profit .11
Contract size x 5,000
Profit $550

Proceeds in the sale of the corn are:
Sale @ 3.18
Crop size x 6,500 bushels
Proceeds $20,670
The total proceeds are $21,220.

Question 22

A short futures position and a short call is equivalent to a short put.

a. True
b. False

Answer 22

b. False
A short futures position and a short call are each bearish positions. Each will be profitable in a declining market either as individual positions, or if used together. A short position in a put is a bullish strategy. The writer of the put will profit by retaining the option premium. This will occur if the futures price rises above the option strike price, causing the option contract to expire worthless.

Question 23

A U.S. importer pays for cars in Japanese yen. The importer is afraid that the dollar will weaken. He should sell yen futures.

a. True
b. False

Answer 23

b. False
The answer is false. An importer who pays for its shipments in a foreign currency would need to hedge against an increase in the cost for that foreign currency. As a user of the foreign currency, the importer is short the basis. To hedge they should take a long foreign currency futures position, or its equivalent. Buying a call option allows the holder the right to take a long position in a futures contract. This would be an effective hedge. If the importer sells the call option, they are obligated (if exercised) to take a short futures position. This is not an effective hedge.

Question 24

A long futures position is inherently less risky than a short futures position.

a. True
b. False

Answer 24

a. True
The maximum loss in a long contract, while substantial, is limited to a futures contract value becoming worthless. The losses attributable to a short futures position are unlimited. There is no maximum value that a futures contract could reach.

Question 25

To offset the purchase of a call an investor would sell a put.

a. True
b. False

Answer 25

b. False
To offset the purchase of a call, an individual would sell the call.

Question 26

A merchant with an inventory of fine gold jewelry would hedge by selling gold futures.

a. True
b. False

Answer 26

a. True
To hedge against a decline in the value of their inventory, a jeweler (who is long the basis) would hedge by selling (shorting) gold futures.

Question 27

Inflation is expected to accelerate. What would you do to speculate in bond futures?

a. Buy futures
b. Sell futures
c. Buy cash bonds and sell futures
d. Sell cash and buy futures

Answer 27

b. Sell futures
An increase in inflation usually leads to an increase in interest rates. Bond futures are price based. If interest rates increase, prices decline. One would speculate by shorting the bond futures.

Question 28

An intramarket spread requires that the same contract be traded on two different exchanges.

a. True
b. False

Answer 28

b. False
The answer is false. An intramarket spread involves the purchase and sale of the same commodity, on the same exchange, but having different delivery months. This is also called an interdelivery spread. The purchase and sale of the same commodity executed on two different exchanges, is an intermarket spread.

Question 29

Which of the following choices is not part of the specifications of a futures contract?

a. Quantity per contract
b. Delivery points
c. Margin requirements
d. Deliverable grades

Answer 29

c. Margin requirements
Margin requirements, although specified by the exchanges, are not part of the specifications of a futures contract

Question 30

What is not needed to have an effective futures market?

a. A minimal amount of government regulation of the cash commodity
b. The commodity must be storable
c. An economic basis for the contract
d. A large number of traders willing to buy and sell the contract

Answer 30

b. The commodity must be storable
Commodities do not need to be storable in order for an effective futures market to exist. Perishable commodities, such as beef and pork, have futures contracts available. Financial futures, such as index futures do not have physical commodities underlying the contract. In these cases, the concept of storage has no bearing on the ability to create and trade a futures contract.

Question 31

A wheat dealer thinks he can make a profit if he can get wheat at $3.15 or lower. He quotes a customer a price of $3.25. The dealer hedges at $3.07 and later closes out at $3.12. He buys the wheat in the cash market at $3.10. What is the dealer’s net profit?

a. 5 cents
b. 10 cents
c. 15 cents
d. 20 cents

Answer 31

d. 20 cents
To answer this question it is necessary to determine exactly what the dealer has done. The dealer quotes a price to sell wheat @ $3.25 to a customer. To hedge their short position, the dealer buys the wheat futures contract @ $3.07 and later sells the futures contract at $3.12, earning a 5-cent profit. The dealer purchases wheat in the market for $3.10. Having already established a selling price of $3.25, the dealer has a 15-cent profit on the wheat. The dealer’s total profit is 20 cents.

Question 32

If a customer buys ten 125 copper calls at 10.45 and later sells the calls at 10.55. If the size of each copper futures contract is 25,000 pounds, what is the customer’s gain or loss?

a. $2,650 gain
b. $2,650 loss
c. $250 gain
d. $250 loss

Answer 32

c. $250 gain
To answer this question, it is necessary to know that copper is quoted as cents per pound.

The customer buys the copper call options @ 10.45 cents per pound. They sell the options @ 10.55 cents per pound. Their profit is .10 cents per pound or .001 dollars per pound. The contract size is 25,000 pounds. The client has 10 contracts. To calculate the profit, the profit per unit is multiplied by the contract size, which is in turn multiplied against the number of contracts.

.001 X 25,000 X 10 = $250.00 profit

Question 33

A wash sale refers to offsetting a futures position.

a. True
b. False

Answer 33

b. False
The term wash sale refers to orders which are intended to give the appearance of activity. They violate exchange rules.

Question 34

In which of the following situations should the designation “OB” be used on an order?

a. On a sell limit order at 17 when the contract is currently at 17.50
b. On a buy limit order at 17 when the contract is currently at 17.50
c. On a sell limit at 17 when the contract is currently at 16.50
d. None of the above

Answer 34

a. On a sell limit order at 17 when the contract is currently at 17.50
OB is the abbreviation for “or better”. This designation is applicable in the case of marketable limit orders. These orders include buy limit orders which, when placed, have a limit price higher than the current offer price, and sell limit orders in which the limit is less than the current bid price.

Question 35

A speculator sells a Treasury note contract at 80-06 and later offsets at 80-22. (T-note contracts have a face value of $100,000.) What is the speculator’s gain or loss?

a. Gain of $1,600
b. Gain of $500
c. Loss of $5,000
d. None of the above

Answer 35

d. None of the above
A client shorts T-Notes @ 80-06 They purchase the T-Notes @ 80-22 The client has a loss of 16 or 16/32 of a point. Each 32nd of a point has a value of $31.25. The loss = 16 x $31.25 = $500.

Question 36

A U.S. automobile importer makes payment in Japanese yen. The importer expects the dollar to fall relative to the yen. To hedge against foreign exchange losses, the importer would buy Japanese yen futures.

a. True
b. False

Answer 36

a. True
The answer is true. If an importer makes payment in a foreign currency, they are short the basis. The proper hedge would be to go long futures contracts.

Question 37

APs are responsible for the collection of margin from clients.

a. True
b. False

Answer 37

**a. True** 
 Associated persons (APs) collect monies from clients in the name of the FCM or CPO. APs may not collect money in the name of the Introducing Broker, nor in the name of the Commodities Trading Adviser.

Question 38

Short positions in index futures that remain open after the last day of trading always settle with a cash payment by the short to the long.

a. True
b. False

Answer 38

b. False
It is unlikely that the customer who is short the contract will be required to make any payment on the final day of the contract. Index futures are marked to market at the end of each day. On the last day of the contract, the individual who has shorted the contract will sustain a reduction of their current equity position if the futures value has increased above the previous days close. The short position would only be required to deposit money (on the last day of the contract), if the rise in the futures value more than offset the equity in their account. As a final point, the customer would be required to make payment to their FCM, not to the customer who is long the futures contract.

Question 39

If a commodity futures market goes limit up:

a. Trading is suspended for the rest of the day in the delivery months that are limit up
b. Only market orders may be accepted
c. Only orders for options may be accepted
d. Orders with prices at the limit up price or lower may be executed

Answer 39

d. Orders with prices at the limit up price or lower may be executed
If the price on a futures contract goes limit up or limit down, trading may still occur. Trades may not be executed beyond the pricing limits during that trading session.

Question 40

A copper buyer puts on a hedge when the basis is 22 cents under. When the hedge is lifted, the basis is 27 cents under. A copper contract covers 25,000 pounds. The result of the hedge is a:

a. Loss of 49 cents
b. Loss of 5 cents
c. Gain of 22 cents
d. Gain of 5 cents

Answer 40

d. Gain of 5 cents
A buyer of copper (user) would profit if the basis weakens. If the basis is under (cash is less than the futures price) and the difference between the cash and futures prices increases, then the basis has weakened. The weakened basis would equate to a gain for the user. When the basis moves from 22 cents under to 27 cents under, the basis has weakened. The result of this hedge is a 5-cent gain for this user of copper.

Question 41

Brokerage Firm A executes an order on behalf of a customer of Brokerage Firm B. This is:

a. Bucketing
b. A give up
c. An account transfer
d. An exchange for physicals

Answer 41

b. A give up
By definition, a give up occurs when one brokerage firm or FCM executes an order on behalf of another brokerage firm.

Question 42

When small rallies in the market are met by substantial selling and small declines are met by substantial buying, this is called:

a. Manipulation
b. Backwardation
c. Congestion
d. Resistance

Answer 42

c. Congestion
By definition, this describes congestion. If the normal forces of supply and demand create this condition, there is no evidence of manipulation. Backwardation describes an inverted market. Resistance is the tendency for prices to retrace once they have risen to a certain level.

Question 43

A speculator buys a soybean contract at $8.00. The initial margin required is 30 cents per bushel and the trader deposits $1,500. If the soybean contract loses 3% in value, what percent of the original margin is lost?

a. 80%
b. 10%
c. 3%
d. 1%

Answer 43

a. 80%
The client goes long soybeans at 8.00. If the contract value declines by 3%, this results in a 24-cent loss of equity (8.00 x .03 = .24). A 24-cent loss represents 80% of the client’s original margin deposit of 30 cents.

Question 44

A stop order to buy is used to:

a. Liquidate a long position in a rising market
b. Liquidate a long position in a falling market
c. Liquidate a short position in a rising market
d. Liquidate a short position in a falling market

Answer 44

c. Liquidate a short position in a rising market
Short positions lose value as the market price rises above the contract price. In order to close out this position, it is necessary to buy the contract. Buy stop orders are placed above the present market value to close out short positions in the case of a rising market.

Question 45

Short covering refers to the practice of selling futures contracts short.

a. True
b. False

Answer 45

b. False
The answer is false. Short covering refers to offsetting a short future position. This is accomplished by buying futures to offset the short position.

Question 46

If the buyer of a futures call option decides to exercise, the seller will:

a. Be assigned a long futures position
b. Be assigned a short futures position
c. Sell the buyer the underlying commodity at the strike price
d. Buy the underlying commodity at the strike price

Answer 46

b. Be assigned a short futures position
The seller of a call on a futures receives the option premium and assumes the obligation to sell a futures contract if the option contract is exercised. If they did not own the underlying futures contract they would be assigned a short futures position.

Question 47

If the market touches the price of a limit order after that order is entered, the customer is entitled to a fill and can hold the broker responsible if the order is not filled.

a. True
b. False

Answer 47

b. False
Limit orders can only be filled at the specified limit price, or better. If the market moves away from the specified limit price, the customer order will not be executed. If the customer wished to obtain an execution once a specific market point is reached, they may place a “market if touched order.” They would not be guaranteed to receive a specific price for execution.

Question 48

A trader buys four CBOT corn contracts at 3.05 and offsets them at 3.14. If round-turn commissions are $30 and the initial margin is 20 cents per bushel, what is the net return on the initial margin?

a. 42%
b. 48%
c. 39%
d. 45%

Answer 48

a. 42%
The trader buys the contracts@ 3.05
They sell the futures @ 3.14
Profit .09
Contract size x 5,000
Gross profit/contract $450
Commissions - 30
Net profit/contract $420

Margin deposit: .20 for 5,000 bushels/contract = $1,000

Profit: $420/$1,000 deposit = 42% profit

Question 49

If a long position in Major Market Index (MMI) futures is open as of the expiration of the contract, how are the contracts valued?

a. At the closing price of the cash MMI on the last trading day
b. At the closing price of the cash MMI on the next business day
c. At the opening price of the cash MMI on the business day after the last trading day
d. At the close of the next delivery month following the expiration month on the day delivery occurs

Answer 49

a. At the closing price of the cash MMI on the last trading day
The contract value for index futures are valued based upon the closing price of the index on the last trade date of the contract.

Question 50

If the buyer of a futures put option decides to exercise, the seller will:

a. Be assigned a long futures position
b. Be assigned a short futures position
c. Sell the buyer the underlying commodity at the strike price
d. Buy the underlying commodity at the strike price

Answer 50

a. Be assigned a long futures position
The seller of a put assumes the obligation to buy a futures contract, if the option contract is exercised by the holder. If they were not short the underlying futures contract they would be assigned a long futures position.

Question 51

An investor who is bearish on the general trend of the market shorts five S&P 500 futures contracts at the current market price of 1,305.5. The contract multiplier is $250, and the investor is charged a $25 round turn commission per contract. What would the settlement price of the S&P 500 Index need to be in order to provide the investor with a net profit of $5,000?

a. 1,301.5
b. 1,325.5
c. 1,301.4
d. 1,285.5

Answer 51

c. 1,301.4
For the investor to have a net profit of $5,000, he would need to make $1,000 per contract ($5,000 / 5 contracts). Since he also paid a commission of $25 per contract, he would need a gross profit of $1,025.00 per contract.

Since the contract multiplier is $250, he would need a market decline of $1,025 / $250 = 4.1

The short was established at: 1,305.5
Favorable market move of: - 4.1
S&P would need to settle at: 1,301.4

Question 52

An investment adviser with a $15,000,000 portfolio of large-cap stocks decides to hedge his portfolio against an anticipated decline in the market by using DJIA futures contracts. The DJIA is currently at 10,500 and the multiplier is $10. The effective hedge would be:

a. Long 1,429 DJIA futures
b. Short 1,428 DJIA futures
c. Short 142 DJIA futures
d. Long 143 DJIA futures

Answer 52

c. Short 142 DJIA futures
Since the adviser is long the portfolio, he would need to establish a short position in the futures market. The total dollar value for one contract at the current price is $10,500 x 10 = $105,000. The adviser would need $15,000,000 / $105,000 = 142.86 contracts for a perfect hedge. Since there are no fractional contracts and, in order to avoid being considered a speculator, the adviser would need to round the number of contracts down to 142.

Question 53

A speculator who expects a sharp rise in the market decides to purchase 18 DJIA futures contracts. The positions were established at 9,162. Later, he liquidates 10 contracts at 9,155 while the remaining 8 contracts were closed at 9,150. The contract multiplier for the DJIA is $10 and the investor was charged $360 in commissions. What is the net profit or loss for this investor?

a. $2,020 gain
b. $2,020 loss
c. $1,660 gain
d. $1,660 loss

Answer 53

b. $2,020 loss
Long positions were established at: 9,162
10 contracts liquidated at: - 9,155
7 point loss
x $10 multiplier
$70 per contract
x 10 (# of contracts)
$700 loss

Long positions were established at: 9,162
8 contracts liquidated at: - 9,150
12 point loss
x $10 multiplier
$120 per contract
x 8 (# of contracts)
$960 loss
$700 loss on 10 contracts
$960 loss on 8 contracts
$360 loss in commissions
$2,020 total loss

Question 54

A trader decides to take a long position in mini-S&P futures. He places an order to buy 20 contracts and receives a fill at 1,025. The initial margin requirement for mini-S&P futures is $4,000 per contract and the multiplier is $50. The following day S&P futures settle at 1,019.5. What is the equity in the client’s account based on that settlement price?

a. $79,000
b. $74,500
c. $81,000
d. $85,500

Answer 54

b. $74,500
Long position established at: 1,025.0
Settlement at: - 1,019.5
5.5 point loss
x $50 multiplier
$275 per contract
x 20 (# of contracts)
$5,500 loss

Total deposit = 20 x $4,000 = $80,000
Total loss -$5,500
Current equity $74,500

Question 55

A speculator has purchased a call and a put on the same underlying futures contract. This is called a:

a. Basis spread
b. Horizontal spread
c. Vertical spread
d. Long straddle

Answer 55

d. Long straddle
Buying a call and a put on the same commodity, with the same expiration date and strike price is known as a long straddle. If the speculator had sold the call and the put, she would have sold the straddle. Spreads involve buying and selling the same type of option (i.e., calls or puts).

Question 56

One of your customers has bought a May $1,700 gold call and sold a May $1,650 gold call. This position is a:

a. Short straddle
b. Basis spread
c. Vertical spread
d. Horizontal spread

Answer 56

c. Vertical spread
A vertical spread is the purchase and sale of the same type of option, with the same expiration date, but a different strike price. A horizontal spread is the purchase and sale of the same type of option, with the same strike price, but a different expiration date. A short straddle is the sale of a call and a put.

Question 57

A farmer sells one wheat contract at $4.00. The market rises 5%. The farmer then sells 2 additional contracts. If the market falls 10% and the farmer offsets all of the positions, what is his total profit or loss?

a. $5,300 profit
b. $7,300 loss
c. $6,700 profit
d. $4,700 loss

Answer 57

a. $5,300 profit
The market starts at $4.00 and rises 5% to $4.20 ($4.00 x .05 =$.20, $4.00 + $.20 = $4.20). The market then falls 10% to $3.78 ($4.20 x .10 = $.42, $4.20 - $.42 = $3.78).

The original contract was sold at $4.00 and covered at $3.78, for a profit of $.22 per bushel. The contract size is 5,000 bushels for a total of $1,100.

The two additional contracts were sold at $4.20 and covered at $3.78, for a profit of $.42 per bushel. The contract size is 5,000 bushels and there are two contracts for a total of $4,200.

If you add the profit on the first contract, $1,100, and the profit on the two subsequent contracts, $4,200, the net profit is $5,300.

Question 58

The current price for July corn is $6.50. The initial margin requirement is $0.50 per bushel, and the contract size is 5,000 bushels. If the July $6.50 corn put is trading at $0.25, what is the margin requirement for someone purchasing 10 puts?

a. $2,500
b. $25,000
c. $1,250
d. $12,500

Answer 58

d. $12,500
The initial margin requirement for someone buying an option is the premium. Buying 10 puts at $0.25 would require a deposit of $12,500 ($0.25 x 5,000 bushels x 10 contracts).

Question 59

The current price for July corn is $6.50. The initial margin requirement is $0.50 per bushel and the contract size is 5,000 bushels. If the July $6.50 corn put is trading at $0.25, what is the margin requirement for someone selling 10 puts?

a. $3,750
b. $37,500
c. $12,500
d. $25,000

Answer 59

b. $37,500
The initial margin requirement for someone selling an in-the-money or at-the-money option is the initial futures margin plus the premium. So the seller would need to deposit the option premium of $12,500 ($0.25 x 5,000 bushels x 10 contracts) and the initial futures margin of $25,000 ($.50 x 5,000 bushels x 10 contracts). The total margin requirement is then $37,500 ($12,500 + $25,000).

Question 60

In March, a customer shorts an August 1700 gold call option with a $10.25 premium. In July, August gold futures rally to $1,714 an ounce. The customer then rolls the option position up and out into the October 1750 call for a premium of $12.05. What is the customer’s profit or loss if the gold futures contract size is 100 Troy Ounces and the customer offsets the August position at 13.47 and the October position at 13.68?

a. A gain of $485
b. A loss of $485
c. A gain of $201
d. A loss of $201

Answer 60

b. A loss of $485
The August option has a loss of $322 (Sold at $10.25 and covered at $13.47 = $3.22/oz. loss x 100 oz. = $322).

The October position has a loss of $163 (Sold at $12.05 and covered at $13.68 = $1.63/oz. loss x 100 oz. = $163). The total loss is $485 ($322 + $163).

Question 61

The June S&P 500 contract is trading at 1424.91 and has an initial margin requirement of $20,000 per contract. If the multiplier is $250 per point, which of the following option positions has the highest initial margin requirement?

a. Long June 1400 S&P 500 call trading at 34.50
b. Long June 1400 S&P 500 put trading at 9.59
c. Short June 1400 S&P 500 call trading at 34.50
d. Short June 1400 S&P 500 put trading at 9.59

Answer 61

c. Short June 1400 S&P 500 call trading at 34.50
For a long position, the initial margin requirement is the option’s premium. Choices (a) and (b) have a margin requirement of $8,625 ($34.50 x $250) and $2,397.50 ($9.59 x $250), respectively.

For a short position, the initial margin requirement is the premium, plus the futures margin, minus 50% of the out-of-the-money amount. Since choice (c) is an in-the-money option, the initial margin is $28,625 ($34.50 x $250 + $20,000). However, since choice (d) is out-of-the- money, the initial margin is $19,283.75 ($9.59 x $250 + $20,000) - [($1,424.91 - $1,400) x $250 x 50%)].