Chapter 12: Options

Question 1

Opening purchase

Answer 1

When an investor 1st buys call or put

Question 2

Opening sale

Answer 2

When an investor 1st sells call or put

Question 3

Closing purchase

Answer 3

When an investor buys self out of previous option that he had sold

Question 4

Closing sale

Answer 4

When an investor sells out of a previous option position that he had purchased

Question 5

Straddle

Answer 5

Long Call
Long Put
      or 
Short Call
Short Put

Same security, strike price, and expiration

Question 6

Sell 1 IBM Jan 10 Call 5

Sell 1 IBM Jan 10 Put 1

Answer 6

Short straddle

Question 7

Buy 1 IBM Jan 10 Call 5

Buy 1 IBM Jan 10 Put 1

Answer 7

Long straddle

Question 8

Sell 1 IBM Jan 10 Call 5

Sell 1 IBM Jan 5 Put 1

Answer 8

Short combination

Question 10

Spread (options)

Answer 10

Long Call 
Short Call
      or
Long Put
Short Put

Question 11

Buy 1 IBM Jan 10 Call 5

Sell 1 IBM Jan 10 Call 1

Answer 11

Long (Bull) Call Spread

Question 11

Buy 1 IBM Jan 5 Put 1

Sell 1 IBM Jan 10 Put 5

Answer 11

Short (Bear) Put spread

Question 12

Buy 1 IBM Jan 10 Call 5

Buy 1 IBM Jan 5 Put 1

Answer 12

Long combination

Question 13

Covered call

Answer 13

Selling a call option on a stock already owned

Question 14

Call holder

Answer 14

• Right to buy

- Bullish

Question 15

Call seller

Answer 15

• Obligation to sell

- Bearish

Question 16

Put holder

Answer 16

• Right to sell

- Bearish)

Question 17

Put seller

Answer 17

• Obligation to buy

- Bullish

Question 18

Call Holder:

Max Gain/Loss

Answer 18

• Max gain = unlimited

- Max loss = premium

Question 19

Call seller:

Max Gain/Loss

Answer 19

• Max gain = Premium

- Max loss = unlimited

Question 20

Put holder:

Max Gain/Loss

Answer 20

• Max gain = strike - premium

- Max loss = premium

Question 21

Put seller:

Max Gain/Loss

Answer 21

• Max gain = premium

- Max loss = strike - premium

Question 22

Call option breakeven point

Answer 22

Strike price + premium

Question 23

Put option breakeven point

Answer 23

Strike price - premium

Question 24

Call option breakeven point

Answer 24

Strike price + premium

Question 25

Put option breakeven point

Answer 25

Strike price - premium

Question 26

Call option breakeven point

Answer 26

Strike price + premium

Question 27

Put option breakeven point

Answer 27

Strike price - premium

Question 28

A call option is in the money when

Answer 28

- The price of the stock is above the strike price | - CALL UP

Question 29

A put option is in the money when ...

Answer 29

- When the price of the stock is below the strike price | - PUT DOWN

Question 30

Intrinsic value

Answer 30

The amount an option is in the money

Question 31

Option premium formula

Answer 31

Premium = Intrinsic value + time value

Question 32

"Calls same"

Answer 32

Premium and strike price go on same side of the chart

Question 33

"Puts switch"

Answer 33

Premium and strike price go in opposite sides of the options chart

Question 34

A call option is in the money when ...

Answer 34

- The price of the stock is above the strike price | - "CALL UP"

Question 35

A put option is in the money when ...

Answer 35

- When the price of the stock is below the strike price | - "PUT DOWN"

Question 36

Intrinsic value

Answer 36

Amount option is in the money

Question 37

Calculate the time value of an option

Answer 37

Premium = Intrinsic Value + Time Value

Question 38

Break-even point for a Call

Answer 38

- "Call Up" | - Strike price + Premium

Question 39

Break-even point for a Put

Answer 39

- "Put Down" | - Strike price - Premium

Question 40

Stock dividends for an options contract

Answer 40

- Number of option contracts remain the same - Strike price decreases - Number of shares per option contract increases

Question 41

Capped index options

Answer 41

- Have a limited max gain or loss because the option will be capped at 30 points in the money - Max gain or loss is $3,000

Question 42

Because of the additional risk involved when investing in options all investors must receive an _________ prior to the first transaction

Answer 42

ODD (Options disclosure document)

Question 43

Which of the following transactions may be executed in a cash account? I. the purchase of a call option II. the sale of a covered call option III. the short sale of a stock IV. the sale of a naked option A. I only B. I and II C. I and III D. III and IV

Answer 43

B. I and II The purchase of call options and the sale of covered call options may be executed in cash accounts. Because of the additional risk, short sales, the sale of naked options, and spreads must be executed in margin accounts.

Question 44

Your client writes a naked put option on ABC common stock. What is the maximum loss per share that the client can incur? A. strike price minus the premium B. strike price plus the premium C. the entire premium received D unlimited

Answer 44

A. strike price minus the premium When writing (selling) a naked (uncovered) call option, the maximum loss is unlimited. However, when writing a naked put option, the maximum loss is the strike (exercise) price minus the premium. Put options go in the money when the price of the stock drops below the strike price. This means that a put option can go only so far in the money because the price of the underlying stock can only drop to zero. Therefore, the maximum loss per share is the strike price less whatever the client received per share when he sold the option.

Question 45

Bullish option strategies include I. buying calls II. buying puts III. writing in the money calls IV. writing in the money puts A. I and III B. I and IV C. II and III D. II and IV

Answer 45

B. I and IV Buying calls is a bullish strategy because the investor wants the price of the underlying security to increase. In addition, selling in the money put options is also bullish because the seller wants the price of the underlying security to increase. When selling a naked option, the most an investor can hope to make is the premium received, therefore the seller wouldn't want the put option to go into the money more; he'd want the underlying stock to increase in value

Question 46

Which option is out of the money if ABC is at $40? A. ABC May 45 put B. ABC May 35 call C. ABC May 50 call D. ABC May 55 put

Answer 46

C. ABC May 50 call The phrase "call up and put down" will help you remember that call options go in the money when the price of the stock goes above the strike price, and put options go in the money when the price of the stock goes below the strike price. A. is in the money because the price of the stock is below the put price of 45. B. is in the money because the price of the stock is above the 35 call strike price. D. is in the money because the price of the stock is below the 55 put strike price. However, C is out of the money because the price of the stock is below the 50 call strike price.

Question 47

An ABC Dec 50 call is trading for 9 when ABC is at $55. What is the time value of this option? A. 0 B. 4 C. 5 D. 9

Answer 47

B. 4 ``` P = I + T 9 = 5 + T T = 4 ```

Question 48

An investor would face an unlimited maximum loss potential if I. writing 3 ABC Dec 25 puts II. shorting 200 shares of ABC III. writing 4 ABC Dec 30 naked calls IV. writing 2 ABC Dec 30 covered calls A. I and II B. I and III C. II and III D. II and IV

Answer 48

C. II and III You have to remember that sellers (writers or shorters) of options always face more risk than the buyers. The buyers' risk is limited to the amount of money they invest. However, sellers of put options don't face a maximum loss potential that is unlimited because put options go in the money when the price of the stock drops below the strike price, and it can only go down to zero.

Question 49

An investor who is long a call option realizes a profit if exercising the option when the underlying stock price is A. above the exercise price plus the premium paid B. below the exercise price C. below the exercise price minus the premium paid D. above the exercise price

Answer 49

A. above the exercise price plus the premium paid In order for an investor to profit from a long call position, he'd have to exercise the option when the market price is above the exercise (strike) price plus the premium paid.

Question 50

When selling an uncovered put, an investor would realize a profit in all of the following situations EXCEPT A. the price of the underlying stock increases in value above the strike price of the option B. the premium of the put option decreases C. the option expires exercised D. the option is exercised when the price of the underlying stock is below the strike price minus the premium

Answer 50

D. the option is exercised when the price of the underlying stock is below the strike price minus the premium When selling an uncovered put option, an investor takes a bullish position. The maximum potential gain is the premium received. In other words, the investor doesn't want this option to be exercised because he'll start losing money and possibly even end up taking a loss. Therefore, D is the correct answer.

Question 51

Which of the following option contracts are in the money when ABC is trading at $43.50? I. short ABC 35 call II. short ABC 40 put III. long ABC 40 call IV. long ABC 50 put A. I, III, and IV B. II and IV C. III and IV D. I, II, and III

Answer 51

A. I, III, and IV Call options go in the money when the market price is greater than the strike (exercise) price. Put options go in the money when the market price is lower than the strike price.

Question 52

If holding which of the following positions would an investor deliver the stock if exercised? A. long a call or short a call B. long a call or short a put C. long a put or short a call D. long a put or short a put

Answer 52

C. long a put or short a call Investors who are long a put or short a call deliver a stock when the option is exercised. Long a call is the right to buy the stock. Long a put is the right to sell the stock. Short a call is the obligation to sell the stock. Short a put is the obligation to buy the stock.

Question 53

One of your clients is convinced that ABC common stock will decline in value over the next few months. Which investment strategy would you recommend to your client that would allow him to take advantage of the expected decline with the smallest cash investment? A. buying an ABC call option B. buying an ABC put option C. shorting ABC stock D. buying an ABC straddle

Answer 53

B. buying an ABC put option You should have knocked out A right away because buying a call option is a bullish strategy. C and D would work but they aren't the cheapest options. Buying a straddle is ideal when you aren't sure which direction the stock is going because you're buying a put and buying a call. When shorting a stock, an investor has to come up with 50% of the market value. Buying a put is the best answer because it's a bearish strategy, and investors can have an interest in a large amount of securities for a small outlay of money.

Question 54

If an investor sells a covered call on stock owned in an account, which of the following is TRUE? A. the premium increases the cost basis B. the premium decreases the cost basis C. the investor has unlimited risk D. the trade must be executed in a margin account

Answer 54

B. the premium decreases the cost basis Selling covered calls reduces the cost basis (the amount he stands to lose). The best way to see this is to use sample numbers. Say that an investor purchased stock for $50 per share and then sold a covered call for $3. He originally spend $50 per share and then got $3 back, so his cost basis was reduced from $50 to $47 ($50-$3).

Question 55

Options of the same series have the same I. stock II. expiration date III. strike price IV. type A. I only B. I and III C. I, II, and III D. I, II, III, and IV

Answer 55

D. I, II, III, and IV Type means calls or puts.

Question 56

The break-even point for an investor who is short a put is A. the market price minus the premium B. the market price plus the premium C. the strike price minus the premium D. the strike price plus the premium

Answer 56

C. the strike price minus the premium The best way to determine the break-even point for an investor who has only an option position is to remember "call up and put down." Because this is a put option you need to put down by subtracting the premium from the strike price. This answer would apply whether the investor was long or short the put.

Question 57

The profit on an option transaction will be taxed as A. a capital gain B. ordinary income C. investment income D. passive income

Answer 57

A. a capital gain All option transactions will result in a capital gain, a capital loss, or a break-even position.

Question 58

Unless otherwise stated, a stock option contract represents A. 1 share of the underlying security B. 10 shares of the underlying security C. 100 shares of the underlying security D. 1,000 shares of the underlying security

Answer 58

C. 100 shares of the underlying security

Question 59

When can European style options be exercised? A. any time B. 1 business day prior to expiration C. 3 business days prior to expiration D. any time during the expiration month

Answer 59

B. 1 business day prior to expiration Unlike American style options, which can be exercised at any time, European style options can be exercised 1 business day prior to expiration. Almost all options are American style but world currency options may be either.

Question 60

A customer with no existing position writes 1 ABC July 60 put and 1 ABC July 60 call. The position established is a A. short combination B. long combination C. long straddle D. short straddle

Answer 60

D. short straddle A straddle consists of a put and a call on the same stock with the same strike price and expiration

Question 61

Which of the following would affect the premium of an option? I. volatility of the underlying security II. the amount of time until the option expires III. the intrinsic value A. I and II B. II and III C. I and III D. I, II, and III

Answer 61

D. I, II, and III

Question 62

Which of the following is the riskiest option strategy? A. Buying calls B. Buying puts C. Selling uncovered calls D. Selling uncovered puts

Answer 62

C. Selling uncovered calls When purchasing an option, the most you can lose is the premium. Therefore option sellers always face more risk than option buyers. When selling uncovered call options the maximum loss potential is unlimited because call options go in the money when the price goes above the strike price. In theory the price of the stock can keep going up.

Question 63

Which of the following would affect the premium of an option? I. volatility of the underlying security II. the amount of time until the option expires III. the intrinsic value A. I and II B. II and III C. I and III D. I, II, and III

Answer 63

D. I, II, and III

Question 64

Which of the following is the riskiest option strategy? A. Buying calls B. Buying puts C. Selling uncovered calls D. Selling uncovered puts

Answer 64

C. Selling uncovered calls When purchasing an option, the most you can lose is the premium. Therefore option sellers always face more risk than option buyers. When selling uncovered call options the maximum loss potential is unlimited because call options go in the money when the price goes above the strike price. In theory the price of the stock can keep going up.

Question 65

Standard option contracts are issues with an expiration of A. 6 months B. 9 months C. 12 months D. 39 months

Answer 65

B. 9 months LEAPS have expiration of up to 39 months.

Question 66

An investor sells 1 ABC Jun 40 put at 6. What is the breakeven point? A. 34 B. 40 C. 46 D. cannot be determined

Answer 66

A. 34 The easiest way to determine the breakeven point for an individual option is to remember call up and put down. Call up: add the premium to the call strike price. Put down: subtract the premium from he strike price. Here: you must put down, 40 - 6 = 34

Question 67

An investor writes an ABC Dec call for 7. What is this investor's maximum potential gain? A. $700 B. $5,300 C. $6,700 D. unlimited

Answer 67

A. $700 This question should be easy. You can use an options chart but it's probably not necessary. The question doesn't mention anything about this investor having any other stock or option positions so you're just dealing with an individual option. Because this investor sold the option the most he can hope to make is then premium received.

Question 68

An investor writes 1 ABC Dec 40 put at 3.25. If the put option is exercised when ABC is trading at $37.50 and the investor immediately sells the stock in the market, what is her gain or loss excluding commissions?

Answer 68

OUT | IN -4000 | 325 | 3750 -4000 | 4075

Question 69

An option position in which the investor buys a call and a put or sells a call and a put on the same underlying security with the same strike (exercise) price and the same expiration month is called a ________

Answer 69

Straddle A "long straddle" is simply 2 calls and a "short straddle" is simply 2 puts.

Question 70

An option position in which the investor buys and sells either a call or a put on the same underlying security is called a ________

Answer 70

Spread A "call spread" is simply buying and selling 2 calls. A "put spread" is simply buying and selling 2 puts.

Question 71

Buying and selling 2 calls in which the buy option has a higher premium than the sell option is called a _______

Answer 71

Long call spread. Also known as a debit call spread because on an option chart the investor is down money. (short call spread is the opposite)

Question 72

Which of the following option positions provides an investor with potential premium income while limiting the maximum loss potential? A. debit spread B. credit spread C. long straddle or long combination D. short straddle or short combination

Answer 72

B. credit (short) spread If the investor is looking for potential premium income, he must have sold something, so you can rule out choice C. Because the maximum loss potential for a short straddle or short combination is unlimited and the investor wants to limit his loss, you can cross out choice D. The only answer that works is a credit spread. To create a credit (short) spread, the investor sells an option that will be in the money first and purchases that will go in the money later. If the option never goes in the money, the investor gets to keep the premium of the option sold. To limit the loss, the investor purchases an option that will go in the money later. This position provides potential premium income and limits the potential loss.

Question 73

The maximum loss potential for a short straddle or a short combination is _________

Answer 73

Unlimited

Question 74

The ________ is the issuer and guarantor of all listed options. It decides which options will trade and their strike prices. In addition, when an investor decides to exercise his option, it randomly decides which firm on the other end will be responsible for fulfilling the terms of the option

Answer 74

Options Clearing Corporation

Question 75

The ________ provides last sale information and current option quotations provided by participating exchanges. It collects data from exchanges like AMEX, the Boston Stock Exchange, and the Philidelphia Stock exchange and disseminates the info it collects

Answer 75

Options Price Reporting Authority (OPRA)

Question 76

Because of the extra risk of investing in options, all option order tickets must be signed by a ________, which is a manager with a Series 4 license.

Answer 76

Registered options principal (ROP)