Chapter 9: Options Intermediate Test: Index Options

Question 1

A customer buys 1 OEX JAN 460 call at 3.20 when the index is 461.
Later, the index rises to 472 and the call is trading at 13.70.
What type of Index option is this?
A. premium
B. breakeven
C. intrinsic value
D. time value
E. cash received on exercise
F. profit on exercise
G. profit if closed

Answer 1

Type: Long Index Call

Calculations:
Premium = 3.20 × 100 = $320
Breakeven = 460 + 3.20 = 463.20
Intrinsic value at purchase = 461 − 460 = $100
Time value at purchase = 320 − 100 = $220
Cash received on exercise = (472 − 460) × 100 = $1,200
Profit if exercised = 1,200 − 320 = $880
Profit if closed = (13.70 × 100) − 320 = $1,050

Breakeven:
463.20

Intrinsic Value:
$100

Time Value:
$220

Cash Received on Exercise:
$1,200

Profit on Exercise:
$880

Profit if Closed:
$1,050

Rationale:
Because the investor purchased the call, the breakeven is the strike price plus the premium. When the index rises, exercising produces the intrinsic value in cash. However, closing the position yields more because the option still contains time value. As long as time value remains, closing the option always produces a higher profit than exercising.

Question 2

A customer buys 1 SPX FEB 3900 put at 14.50 when the index is 3892.
Later, the index falls to 3870 and the put is trading at 32.40.
What type of Index option is this?
A. premium
B. breakeven
C. intrinsic value
D. time value
E. cash received on exercise
F. profit on exercise
G. profit if closed

Answer 2

Type: Long Index Put

Calculations:
Premium = 14.50 × 100 = $1,450
Breakeven = 3900 − 14.50 = 3885.50
Intrinsic value at purchase = 3900 − 3892 = $800
Time value at purchase = 1450 − 800 = $650
Cash received on exercise = (3900 − 3870) × 100 = $3,000
Profit on exercise = 3,000 − 1,450 = $1,550
Profit if closed = (32.40 × 100) − 1,450 = $1,790

Breakeven:
3885.50

Intrinsic Value:
$800

Time Value:
$650

Cash Received on Exercise:
$3,000

Profit on Exercise:
$1,550

Profit if Closed:
$1,790

Rationale:
Because the investor purchased the put, the breakeven is the strike price minus the premium. Exercising produces the intrinsic value in cash, but closing the option yields more because the option still contains time value. When time value remains, closing always results in a higher profit than exercising.

Question 3

A customer buys 1 NDX MAR 15,000 call at 22.10 when the index is 15,012.
Later, the index rises to 15,090 and the call is trading at 105.50.
What type of Index option is this?
A. premium
B. breakeven
C. intrinsic value
D. time value
E. cash received on exercise
F. profit on exercise
G. profit if closed

Answer 3

Type: Long Index Call

Calculations:
Premium = 22.10 × 100 = $2,210
Breakeven = 15,000 + 22.10 = 15,022.10
Intrinsic value at purchase = 15,012 − 15,000 = $1,200
Time value at purchase = 2210 − 1200 = $1,010
Cash received on exercise = (15,090 − 15,000) × 100 = $9,000
Profit on exercise = 9,000 − 2,210 = $6,790
Profit if closed = (105.50 × 100) − 2,210 = $8,340

Breakeven:
15,022.10

Intrinsic Value:
$1,200

Time Value:
$1,010

Cash Received on Exercise:
$9,000

Profit on Exercise:
$6,790

Profit if Closed:
$8,340

Rationale:
Because the investor purchased the call, the breakeven is the strike price plus the premium. Exercising produces the intrinsic value in cash, but closing the option yields more because the option still contains time value. Closing is always superior when time value remains.

Question 4

A customer buys 1 OEX APR 520 put at 6.40 when the index is 517.
Later, the index falls to 505 and the put is trading at 18.90.
What type of Index option is this?
A. premium
B. breakeven
C. intrinsic value
D. time value
E. cash received on exercise
F. profit on exercise
G. profit if closed

Answer 4

Type: Long Index Put

Calculations:
Premium = 6.40 × 100 = $640
Breakeven = 520 − 6.40 = 513.60
Intrinsic value at purchase = 520 − 517 = $300
Time value at purchase = 640 − 300 = $340
Cash received on exercise = (520 − 505) × 100 = $1,500
Profit on exercise = 1,500 − 640 = $860
Profit if closed = (18.90 × 100) − 640 = $1,250

Breakeven:
513.60

Intrinsic Value:
$300

Time Value:
$340

Cash Received on Exercise:
$1,500

Profit on Exercise:
$860

Profit if Closed:
$1,250

Rationale:
Because the investor purchased the put, the breakeven is the strike price minus the premium. Exercising produces the intrinsic value in cash, but closing the option yields more because the option still contains time value. Closing is always more profitable when time value remains.

Question 5

A customer buys 1 RUT JUN 2100 put at 12.30 when the index is 2094.
Later, the index falls to 2070 and the put is trading at 35.60.
What type of Index option is this?
A. premium
B. breakeven
C. intrinsic value
D. time value
E. cash received on exercise
F. profit on exercise
G. profit if closed

Answer 5

Type: Long Index Put

Calculations:
Premium = 12.30 × 100 = $1,230
Breakeven = 2100 − 12.30 = 2087.70
Intrinsic value at purchase = 2100 − 2094 = $600
Time value at purchase = 1230 − 600 = $630
Cash received on exercise = (2100 − 2070) × 100 = $3,000
Profit on exercise = 3,000 − 1,230 = $1,770
Profit if closed = (35.60 × 100) − 1,230 = $2,330

Breakeven:
2087.70

Intrinsic Value:
$600

Time Value:
$630

Cash Received on Exercise:
$3,000

Profit on Exercise:
$1,770

Profit if Closed:
$2,330

Rationale:
Because the investor purchased the put, the breakeven is the strike price minus the premium. Exercising produces the intrinsic value in cash, but closing the option yields more because the option still contains time value. Closing always produces a higher profit when time value remains.