Speculative Strategies Flashcards
The purchase of a call has all of the same characteristics as buying stock EXCEPT:
A. unlimited gain potential in a rising market
B. limited loss potential in a falling market
C. low liquidity risk if the position is to be liquidated
D. no erosion of value as the position is held
The best answer is D.
The purchase of a call has unlimited gain potential, as does the purchase of stock. The maximum loss for a call holder is the premium paid; the maximum loss for a stockholder is his investment - so loss potential is limited for both. Both options and stocks are actively traded on exchanges, so there is little liquidity risk for both. The holder of a call faces the loss of time premium as the position nears expiration; this is not true for stock positions.
A customer buys 1 ABC Feb 50 Call @ $7 when the market price of ABC is $52. The stock moves to $80 and the customer exercises the call and sells the stock at the current market price. The gain or loss to the customer is:
A. $700 loss
B. $700 gain
C. $2,300 gain
D. $3,000 gain
The best answer is C.
The holder has bought the right to buy the stock at $50 per share. She bought this right for a premium of $7 per share. By exercising the call, the holder buys the stock at $50 and then sells the stock in the market at $80, for a 30 point gain. Since 7 points was paid in premiums, the net gain is 23 points or $2,300 on the contract covering 100 shares.
A customer buys 1 ABC Feb 50 Call @ $7 when the market price of ABC is 52. If the market value of ABC falls to $48 and stays there through February, the customer will:
A. gain $700
B. lose $700
C. gain $4,300
D. lose $4,300
The best answer is B.
If the market falls to $48, the 50 call expires out the money and the holder loses the $700 premium paid.
In November, a customer buys 1 ABC Jan 70 Call @ $4 when the market price of ABC is $71. The breakeven point for the position is:
A. $66
B. $67
C. $74
D. $75
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 $4 for the right to buy stock at $70. The effective cost if he or she exercises is $74. The holder must be able to sell the stock for $74 to breakeven.
To summarize, the formula for breakeven on a long call
is:
Long Call B/E = SP + Pre
In November, a customer buys 1 ABC Jan 70 Call @ $4 when the market price of ABC is 71. The customer’s maximum potential gain is:
A. $400
B. $6,600
C. $7,400
D. unlimited
The best answer is D.
The holder of a call has unlimited gain potential. He or she has the right to buy stock at a fixed price - and the stock can rise an unlimited amount
A customer buys 10 ABC Jan 50 Calls @ 4.75 when the market price of ABC is $51 per share. The maximum loss potential is:
A. $4,750
B. $45,125
C. $50,000
D. unlimited
The best answer is A.
If the market stays at 50 or falls, the calls will expire worthless and the premium paid is lost. There are 10 contracts so, $4.75 x 10 contracts x 100 shares in each contract gives a total loss of $4,750.
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.
The sale of an “at the money” call is a:
A. bull strategy
B. bear strategy
C. neutral strategy
D. bear/neutral strategy
The best answer is D.
The seller of a call has the obligation to deliver stock at a fixed price in a rising market, in return for which the writer collects a premium. If the market stays the same, or falls, the call expires and the writer keeps the collected premium. This is a bear/neutral market strategy.
What are the profit/loss characteristics of taking a short call position?
A. Unlimited upside (profit) and unlimited downside (loss)
B. Unlimited upside (profit) and limited downside (loss)
C. Limited upside (profit) and unlimited downside (loss)
D. Limited upside (profit) and limited downside (loss)
The best answer is C.
A short call position obligates the writer to sell the stock at a fixed price (and this person does not own the stock!). If the market price keeps rising, the writer keeps losing, so the loss potential is unlimited. On the other hand, if the market price falls below the strike price, the call expires worthless. Then the customer’s gain is limited to the premium paid.
A customer sells 1 ABC Feb 50 Call @ $7 when the market price of ABC is $52. The stock moves to $80 and the customer is assigned. The stock is bought in the market for delivery. The gain or loss to the writer is:
A. $700 gain
B. $700 loss
C. $2,300 loss
D. $3,000 loss
The best answer is C.
A call writer, when exercised, is obligated to deliver stock at $50 per share. He or she must buy the stock at $80 in the market, losing 30 points. Since $700 (7 points) was collected in premiums, the net loss is 23 points or $2,300.
A customer sells 1 ABC Feb 40 Call @ $7 when the market price of ABC is $39. The stock moves to $50 and the customer is assigned. The stock is bought in the market for delivery. The gain or loss to the writer is:
A. $300 gain
B. $300 loss
C. $700 loss
D. $1,100 loss
The best answer is B.
The writer of the call, when exercised, is obligated to deliver stock at $40 per share. He or she must buy the stock at $50 in the market, losing 10 points. Since $700 (7 points) was collected in premiums, the net loss is 3 points or $300.
A customer sells 1 ABC Feb 50 Call @ $7 when the market price of ABC is $52. If the market value of ABC falls to $48 and stays there through February, the customer will:
A. gain $700
B. lose $700
C. gain $4,300
D. lose $4,300
The best answer is A.
If the market falls to $48, the 50 call expires “out the money” and the writer keeps the $700 premium.
In November, a customer sells 1 ABC Jan 70 Call @ $4 when the market price of ABC is $71. If ABC falls to $67 and stays there through January, the customer will:
A. gain $400
B. lose $400
C. gain $6,700
D. lose $6,700
The best answer is A.
The writer of a call receives the premium for the contract. For a call, the contract will remain unexercised if the market price is below the strike price. The premium received is the maximum gain if the contract expires “out the money.”
In November, a customer sells 1 ABC Jan 70 Call @ $4 when the market price of ABC is $71. The breakeven point for the position is:
A. $66
B. $67
C. $74
D. $75
The best answer is C.
The writer of a call must lose the $4 in premiums received in order to breakeven. When the market goes to 74, the $4 will be lost (buy the shares at $74 and deliver the shares at $70) and the customer would break even at this point.
To summarize, the formula for breakeven on a short call is:
Short Call B/E= Strike Price+Premium
A customer sells 1 ABC Jan 50 Call @ $3 when the market price of ABC is at $52. The maximum potential gain for the position is:
A. $100
B. $200
C. $300
D. unlimited
The best answer is C.
The maximum potential gain when selling a naked call option is the premium received. This occurs if the market drops and the call expires “out the money.”
