Unit 9 | Options Flashcards
An investor buys 100 shares of CDL stock at $50. Two months later, with CDL selling for $48, the investor writes a CDL APR 45 call for a premium of $4. If the buyer exercises the option, the investor’s maximum potential loss is
A. zero.
B. $100.
C. $400.
D. unlimited.
B. The investor had bought a stock for $5,000 and received a premium of $4. Therefore, the net cost of the position came to $4,600. If the price of CDL goes up and an exercise notice is assigned, the investor will have to deliver the stock that is currently owned and, in return, receive a strike price of $45, i.e., $4,500. This will result in a loss of $100.
An investor selling 1 KLP Dec 45 call at 3 has a maximum potential gain of
A. $300.
B. $4,200.
C. $4,800.
D. unlimited.
A. The maximum profit on a short call is the premium received. For one contract (100 shares), if the seller received $3 per share, the profit is $300.
If an investor buys 1 ALF Jan 50 put at 2, the maximum potential gain is
A. $200.
B. $4,800.
C. $5,200.
D. unlimited
B. To calculate the maximum gain on a long put, subtract the premium paid from the strike price. For example, if the strike price is 50 and the premium paid is 2, then the maximum potential gain can be calculated by multiplying the difference (50 - 2 = 48) by the number of shares in the contract, which is typically 100. In this case, the maximum gain would be $4,800.
An investor establishes a spread position by going long 1 LMN OCT 80 call at eight and short 1 LMN OCT 90 call at 2.75. What are the maximum gain and the maximum loss?
I. Maximum gain, $475
II. Maximum gain, $525
III. Maximum loss, $475
IV. Maximum loss, $525
A. I and III
B. I and IV
C. Il and III
D. Il and IV
B. To compute the debit (or credit), the first step is to add up the cost of the long option, which is eight, while also considering the amount brought in by the short option, which is 2.75. This results in a 5.25 debit.
The maximum gain that can be obtained is $475. To calculate the maximum gain on a debit spread, we need to subtract the net debit from the difference between the strike prices. In this case, it is 10 - 5.25 = 4.75. Multiplying this by 100 shares, we get $475.
On the other hand, the maximum loss that can be incurred is $525. The maximum loss on a debit spread is equivalent to the net debit. It is important to note that the maximum gain and the maximum loss always add up to the spread.
An investor establishes a spread by going long 1 DEF FEB 60 put at three and short 1 DEF FEB 70 put at 7. Before expiration, DEF is selling for 68, and both positions are closed out at their intrinsic value. As a result, the investor has
A. a loss of $200.
B. a gain of $200.
C. a loss of $600.
D. a gain of $600.
B. By using the T-chart, we see this is a credit spread with a net credit of $400. With the price of DEF at $68, the 60 put is out of the money and would be closed by a sale at zero. The 70 put is 2 points in the money, and the closing purchase at intrinsic value would cost $200. As the premium spread has narrowed from 4 points to 2 points, the investor made $200.
DR | CR
3. | 7
2. | 0
5. | 7
As a bull spread, if the DEF reached 70 or higher, both options would expire unexercised, and the entire 4 points would be profit to the investor. On the other hand, if DEF’s price drops to 60, the 70 put would be exercised at a 10-point loss. After subtracting the initial 4-point credit, that would give this investor a net loss of $600. We knew that would be the maximum loss because, with a maximum gain of 4 of the 10-point difference between 60 and 70, the maximum loss is the rest of the spread.
An investor establishes a spread position by going long 1 GHI 30 MAR call and short 1 GHI 35 MAR call. When will the investor will profit?
I. When the spread narrows Il. When the spread widens
III. When GHI is at 30 or below IV. When GHI is at 35 or above
A. I and III
B. land V
C. Il and III
D. Il and IV
D. This appears to be a bull call spread because the investor bought a call option with a lower strike price and sold a call option with a higher strike price. Additionally, it seems to be a debit spread, even though no premiums are shown. How can we tell? Well, in the case of call options, the lower the strike price, the higher the premium. Therefore, regardless of the specific premium amounts, we can safely assume that the premium to buy a 30 call will always be higher than the premium received from selling a 35 call.
Bull spreads, like this one, generally benefit when the underlying asset price goes up. The investor in this scenario will see their maximum profit when the stock price reaches 35 or higher. As a debit spread, the investor wants the premium spread to widen, meaning that the difference between the premium paid for the lower strike call option and the premium received from selling the higher strike call option should increase over time.
All of the following options positions have limited potential loss except
A. short uncovered puts.
B. long calls.
C. long puts.
D. short uncovered calls.
D. A short uncovered call has unlimited potential loss because, theoretically, a stock’s price can rise indefinitely. The possible loss on a short uncovered put can be significant but is limited to the put’s strike price minus the premium received per share. The potential loss on a long call or a long put is limited to the premium paid. LO 9.c
If a customer buys 1 XYZ Nov 70 put and sells 1 XYZ Nov 60 put when XYZ is selling for 65, this position is
A. a bear spread.
B. a bull spread.
C. a combination.
D. a straddle.
A. To start with, the first step is to identify the position. A spread is when you purchase one option and sell another of the same class (puts or calls) simultaneously. A call spread is a long call and a short call, while a put spread is a long put and a short put. During the exam, you should expect to come across a question about a spread that doesn’t mention the premiums. In this case, we have a put spread, and we are only given the strike prices. In the case of a put (the ability to sell stock), the option’s value increases with the strike price. Therefore, we know that the 70 put will have a higher premium than the 60 put because it allows us to sell XYZ at a higher price. Consequently, the option purchased (the 70) will cost more than the one sold (the 60), resulting in a debit spread. A debit spread means a net buy, while a credit spread means a net sale. Therefore, a debit put spread is like buying a put, which is bearish. LO 9.d
A customer is short 100 shares of DFI at 35, and the market price is 35.25. If she believes a near-term rally will occur, which strategies would best hedge her position?
A. Buy a DFI call with an exercise price of 40
B. Buy a DFI call with an exercise price of 35
C. Write a DFI put with an exercise price of 40
D. Write a DFI call with an exercise price of 40
B. If you have a short position in a stock, the best hedge is to buy a call option instead of selling a put option. If the stock price increases, you can exercise the call option and use the stock to close out the short position. To get the most protection, the call option’s strike price should equal the price you sold the stock short. LO 9.e
customer is short 100 XYZ shares at 26 and long 1 XYZ 30 call at 1. What is the maximum potential gain for the customer?
A. $5,200
В. $500
С. $2,600
D. $2,500
D. The investor has protected their short stock position from a potential market upswing by purchasing a call. In case the market declines, the investor can earn up to $26 per share if the stock price falls to zero, minus the 1 dollar premium paid to obtain the call. This results in a maximum gain of $2,500 (26 - 1 = 25). LO 9.e
An investor has established the following spread position: long XYZ 50 call at nine and short XYZ 60 call at 5. This investor will benefit if
A. the options expire unexercised.
B. the premiums widen.
C. the premiums narrow.
D. none of these.
B. As we can see in the following T-chart, this is a debit spread, and investors want the spread (difference) between the premiums to widen.
DR | CR
9. | 5
4
An investor who has entered into a debit spread will profit if
A. the spread widens.
B. the spread narrows.
C. the spread remains unchanged.
D. both contracts expire unexercised
A. The key to a debit spread is that the investor wants the options to be exercised or the difference in premiums to widen.
Which of the following scenarios would an investor prefer a more expansive spread?
I. Write 1 May 25 put; buy 1 May 30 put
Il. Write 1 Apr 45 put; buy 1 Apr 55 put
Ill. Buy 1 Nov 65 put; write 1 Nov 75 put
IV. Write 1 Jan 30 call; buy 1 Jan 40 call
A. I and II
B. I and IV
C. Il and III
D. Ill and IV
A. Choices I and Il are debit spreads. An investor wants a debit spread to widen. As the distance between the premiums increases, the investor’s potential profit increases.
Your customer sells a DOH Mar 35 call. To establish a straddle, he would
A. sell a DOH Mar 40 call.
B. buy a DOH Mar 35 put.
C. sell a DOH Mar 35 put.
D. buy a DOH Mar 40 call.
C. A straddle is a popular options trading strategy that involves buying or selling two options contracts with the same expiration date and strike price. It is designed to allow traders to profit from a security’s price movement, regardless of whether it goes up or down. The idea behind a straddle is to take advantage of significant price volatility, which can cause a stock’s price to move sharply in one direction or another. By buying both a call and a put option, traders can benefit from a substantial move in either direction while minimizing losses if the stock price remains relatively stable. This strategy can be particularly effective in markets expected to be highly volatile, such as during earnings announcements or other major news events.
Covered put writing is a strategy where an investor
A. sells a put on a stock he has sold short.
B. sells a put on a stock that he owns.
C. sells a put and sells a call on the same stock.
D. sells a put and buys a call on the same stock.
A. When selling an option, the seller must meet. A call writer must deliver the underlying stock, while a put writer must pay for the stock delivered. If the holder exercises a put option, the seller must have sufficient cash to purchase the stock being put to them. Selling a put is bullish while selling a call is bearish. A way to eliminate answer choices is to remember that hedging involves a stock position and an option position opposite in sentiment.
The first thing to remember is that option sellers have an obligation. In the case of a call writer, the obligation is to deliver the underlying stock. However, in the case of a put (our question), the obligation is to pay for stock delivered. A seller of an option would be covered if he has whatever he is obligated for.
If you sell a put and the option is exercised by the holder, meeting the obligation requires having sufficient cash to purchase the stock being put to you. Owning the shares would not help you meet your obligation; you need money. You will be covered if you have cash available to cover the purchase. One way is a cash deposit at the time the put is written. Alternatively, if you sell 100 shares short for each put sold, you would have cash from the short sale that could be used to cover the obligation to buy the stock at the strike price. Notice that selling a put is bullish; the short stock position is bearish.
An easy way to eliminate answer choices is to remember that hedging involves a stock position and an option position opposite in sentiment. Notice that the sentiments associated with the answer choice “sells a put on a stock that he owns” don’t work because a long stock position and selling a put are bullish. Therefore, this answer can be eliminated.
To prove the point, let’s look at the other side. If you sell a call, you are obligated to sell shares of stock. You would be covered if you already owned the shares. Notice that selling a call is bearish, and owning the stock is bullish. LO 9.f
