UNIT 3 CHECKPOINT EXAM Flashcards
Mikayla is a big fan of Seabird Coffee and is an enthusiastic investor. She currently owns 1,000 shares of the company stock and 10 call contracts on the stock as well. What is her maximum gain for this position?
A) Limited gain on the stock and unlimited gain on the option position
B) Unlimited gain on the stock and limited gain on the option position
C) Limited gain on both the option and stock position
D) Unlimited gain on the stock and the option position
D) Unlimited gain on the stock and the option position
Both long stock and a long call are unlimited gain positions.
Which of the following securities would be least likely to be issued by a corporation?
A) Preferred stock
B) Call and put options
C) Common stock
D) Debentures
B) Call and put options
Corporations issue equity securities (stock) and debt securities (bonds and debentures), but they do not issue options. Options are issued by the Options Clearing Corporation (OCC).
Which of the following positions or actions would cover a client who has shorted a call?
A) Buying a call that expires sooner
B) A long stock position
C) Buying a put with a higher strike price
D) A short stock position
B) A long stock position
A short call (call writer) is a bearish position, which requires the client to deliver stock at the strike regardless of how far the share price rises. A long stock position would hedge the call since the client would already own the deliverable shares. A client who has written a call against an existing long stock position would be considered covered.
If a customer had a large cash position and was interested in purchasing stock at prices below where they are today, an option strategy would be to
A) buy out-of-the-money calls.
B) write covered puts that are currently out of the money.
C) place a buy stop order below the market.
D) write uncovered calls that are currently out of the money.
B) write covered puts that are currently out of the money.
If the stock declines in value and the short put options are exercised, the customer will buy the stock at a price lower than where the market is at this moment. The short calls would force him to sell the shares if exercised. Buying out-of-the-money calls costs money, and the strike price would be higher than the market. Buy stop orders are entered above the current market value of a stock.
CDC Pharmaceutical stock is currently trading at $50 a share. The CDC Nov 45 PUT is trading at one. Based on this information, which of the following is true?
I. Time value is $1.
II. Intrinsic value is $1.
III. The premium must be greater than $1.
IV. Intrinsic value is zero.
A) II and IV
B) I and IV
C) I and III
D) II and III
B) I and IV
The basic formula is intrinsic value plus time value equals the premium (IV + TV = Pr). The intrinsic value of an out-of-the-money option, like this example, is zero. If the premium is one and the intrinsic value is 0, then the time value must be 1 (0 + 1 = 1).
The exercise of an equity option requires that stock must be delivered
A) that day.
B) three business days after the exercise.
C) the next business day.
D) two business days after the exercise.
D) two business days after the exercise.
If an equity option is exercised one side of the contract will need to deliver the shares. If they do not already own those shares then they will go into the market to buy them. The two business days to deliver the shares allows for the purchase and regular way settlement to occur.
Your client, Mickey, just purchased 10 July EuroDollar Put contracts at 1.10. She notices that they are European Style contracts and asks you what the means. You tell her
A) she may exercise the contracts whenever he wants to.
B) she may only exercise the contacts in the last week before expiration.
C) she may only exercise the contracts on the last day of trading before expiration.
D) she may not exercise the contracts. The contracts will exercise at expiration if they are in-the-money.
C) she may only exercise the contracts on the last day of trading before expiration.
European style contracts may only be exercised on the last day the contract trades before expiration. American style may be exercised by the owners at any time. American style is much more common.
Which of these statements regarding options are true?
I. Investors who are bullish on a stock should buy calls.
II. Investors who are bullish on a stock should buy puts.
III. Investors who are bearish on a stock should sell puts.
IV. Investors who are bearish on a stock should buy puts.
A) II and IV
B) I and IV
C) I and III
D) II and III
B) I and IV
Buying calls is bullish and buying puts is bearish. Selling puts is bullish.
Pedro dislikes Seabird Coffee and thinks the company’s stock is overvalued. He is currently short 1,000 shares of the company. He is concerned with the potentially unlimited risk he is exposed to and would like to use options to hedge that risk. His best option position would be
A) buy 10 Seabird Coffee calls.
B) sell 10 Seabird Coffee calls.
C) buy 10 Seabird Coffee puts.
D) buy 10 OEX (S&P 100 index) calls.
A) buy 10 Seabird Coffee calls.
Long calls provide the best protection against a short stock position. The calls give the owner the right to exercise and buy the stock at the exercise price, thereby locking in the cost to replace the shares.
Your customer, Leo, recently purchased one put contract on Napa Valley Spirits, Inc., stock. The strike price is $50.00 and the premium was $4.50. He later executed the contract. How much did he pay for the contract?
A) $5000.00
B) $4,550.00
C) $500.00
D) $450.00
D) $450.00
The question asks what he paid for the contract, not what he received when he executed it, or the breakeven price. One contract of 100 shares at $4.50 a shares is $450.00.
The price that the buyer of a contract pays, or the writer receives, on a per share basis for an option contract is called the
A) time value.
B) premium.
C) intrinsic value.
D) strike price.
B) premium.
Intrinsic value and time value are components of the premium. The strike price is needed to compute the intrinsic value.
The strike price is
A) the price that will be paid for the shares if the option is exercised.
B) the amount the writer of a call pays the seller of the call for the shares.
C) the amount the buyer of a call must pay for the shares.
D) the cost per share of the contract.
A) the price that will be paid for the shares if the option is exercised.
This is the basic definition of strike price. The cost per share of the contract is the premium. The terms writer and seller are the same person in an option transaction. The buyer of a call may choose to exercise and buy the stock, or they may choose not to do so. They have the right (may) but not the obligation (must) to exercise the contract.
CDC Pharmaceutical stock is currently trading at $50 a share. The CDC Nov 55 put is trading at $7. Which of the following is true?
I. The time value is $2.
II. The intrinsic value is $5.
III. The time value is $5.
IV. The intrinsic value is $2.
A) III and IV
B) I and II
C) I and III
D) II and IV
B) I and II
I. The time value is $2.
II. The intrinsic value is $5.
With the stock at $50 a 55 put is $5 in-the-money, or has $5 of intrinsic value. Using the (IV + TV = Pr) formula the time value must be $2 (5 + 2 = 7).
Before an option trade may be entered for a customer, that customer’s account must be approved for option trading by
A) an executive officer.
B) a branch manager.
C) a firm principal.
D) a Registered Options Principal.
D) a Registered Options Principal.
Only an ROP may approve option trading for an account.
The Options Clearing Corporation (OCC) assigns exercise notices to broker-dealers with short positions
A) using a random selection method.
B) using any method that is considered fair and reasonable.
C) on a FIFO basis.
D) on a LIFO basis.
A) using a random selection method.
The OCC assigns exercise notices to short broker-dealers (those with customers who are short) on a random basis. It is the broker-dealers who may then assign exercise notices to their short customers on a random basis; on a first in, first out (FIFO) basis; or any other method that is fair and reasonable.
