Chapter 6 - Options

Question 1

An individual who writes an uncovered call option believes
A) That the underlying stock price will rise above the strike price.
B) General stock market values will be very volatile in the coming weeks.
C) That the underlying stock price will fall below the strike price.
D) That positive news will be forthcoming.

Answer 1

Correct Answer:
C) That the underlying stock price will fall below the strike price.

Answer Explanation
The writer of an uncovered call believes that the market price of the underlying stock will remain below the strike of the option, thereby resulting in the option expiring and allowing the writer to retain the option premium.

Textbook Reference
Please see textbook section 6.2.2.1

Question 2

Two options contracts would be in the same series when they have common
A) Premiums and intrinsic values
B) Strike prices and premiums
C) Expiration months and strike prices
D) Premiums and expiration months

Answer 2

Correct Answer:
C) Expiration months and strike prices

Answer Explanation
Two option contracts are in the same series because they have the same expiration month and strike price.

Textbook Reference
Please see textbook section 6.1.1

Question 3

An investor believes ABC stock will increase in value. What is the most profitable options position that this investor can utilize?
A) Long puts
B) Long calls
C) Short calls
D) Short puts

Answer 3

Correct Answer:
B) Long calls

Answer Explanation
A long call would be the most profitable option position an investor can hold if the value of a particular stock increases in value.

Textbook Reference
Please see textbook section 6.2.1

Question 4

An investor writes an S&P 500 2025 put for 10. Just prior to expiration the S&P is 1980. Which two of the following statements are TRUE?

I. The contract will be exercised
II. The contract will expire
III. The investor profits in this transaction
IV. The investor has a loss in this transaction
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 4

Correct Answer:
A) I and IV

Answer Explanation
The investor received $1,000 to write the index put. The put is exercised because the index value is below the exercise price. Index options settle in cash so the writer must pay $4,500 (2025 — 1980 x 100 multiplier) at exercise. The investor’s loss on this transaction is $3,500 (Paid $4,500, received $1,000).

Textbook Reference
Please see textbook section 6.3.2.1

Question 5

An investor that previously established a long position in puts makes an offsetting transaction in an identical put. This transaction is a(n)
A) Closing purchase
B) Opening sale
C) Closing sale
D) Opening purchase

Answer 5

Correct Answer:
C) Closing sale

Answer Explanation
An investor that previously established a position by buying an option will close the position by selling an identical option to reduce or cancel the position.

Textbook Reference`
Please see textbook section 6.7.1

Question 6

An investor is long an ABC Jan 65 put for a premium of 7. If at expiration the price of ABC is 53, which two of the following statements are TRUE?

I. The contract is profitable to the holder at expiration
II. The contract is in-the-money at expiration
III. The contract will not be exercised
IV. The contract’s breakeven is 72
A) II and IV
B) I and II
C) II and III
D) I and IV`

Answer 6

Correct Answer:
B) I and II

Answer Explanation
A put is in the money whenever the price of the underlying stock is lower than the strike price. This contract is in the money, and profitable to the holder at expiration because the breakeven is 58 (strike price minus premium for puts). The put holder will exercise the contract, and has the right to sell stock at 65. The writer (the party that is short) must buy it, when the current market price is actually 53.

Textbook Reference
Please see textbook section 6.3.1.1

Question 7

With the market price at $67.25 at expiration, a long XYZ 65 call will
A) Be automatically exercised according to OCC provisions
B) Be exercised only if the holder gives exercise instruction
C) expire
D) Be exercised only if the counterparty to the contract has met the initial margin requirement for purchase of the stock

Answer 7

Correct Answer:
A) Be automatically exercised according to OCC provisions

Answer Explanation
The Options Clearing Corporation has provisions for the automatic exercise of certain in-the-money options at expiration. This procedure is also referred to as “exercise by exception.” Generally, the OCC will automatically exercise any expiring equity call or put in a customer account that is $0.01 or more in-the-money, and an index option that is $.01 or more in-the-money. However, the customer’s broker-dealer may have a different threshold for automatic exercise which may or may not be the same as the OCC’s.

Textbook Reference
Please see textbook section 6.6.1

Question 8

An investor sells 5 March 45 ABC put option contracts for a premium of $2.50. After the position turns bad, the investor wishes to cut losses and close out the contracts prior to maturity. How can this be done?
A) Sell 5 March 45 ABC calls
B) Buy 5 March 45 ABC calls
C) Sell 5 March 45 ABC puts
D) Buy 5 March 45 ABC puts

Answer 8

Correct Answer:
D)

Answer Explanation
To close out a contract, an investor takes the opposite side (buy or sell) of the same put or call contract, in the same number of contracts. The opposite side of this trade (sell puts) is to buy puts.

Textbook Reference
Please see textbook section 6.7.2

Question 9

Which of the following is a strategy that is used by investors to secure profits from a stock position that an investor had previously purchased?
A) Short put
B) Uncovered call
C) Protective put
D) Long call

Answer 9

Correct Answer:
C) Protective put

Answer Explanation
A protective put is used to “insure” profits on a long stock position. It gives the buyer the right to sell stock at the exercise price to protect profits that have already been made.

Textbook Reference
Please see textbook section 6.3.4

Question 10

An investor writes 3 XYZ June 65.35 puts at 4.50. Just before expiration, XYZ is trading for 66. Which of the following statements is TRUE?
A) The investor is required to sell 100 shares of stock at 65.35
B) The investor has a profit of $450
C) The investor has a profit of $1,350
D) The investor receives 200 shares of stock at 73

Answer 10

Correct Answer:
C) The investor has a profit of $1,350

Answer Explanation
These puts are out of the money and will expire, so the writer is not obligated to purchase the stock. The buyer will not exercise the right to sell stock at the strike price of 65.35 when it could be sold on the market for 66. The writer profits from the premium of $1,350 received for writing 3 contracts at $450 each.

Textbook Reference
Please see textbook section 6.3.2.1

Question 11

An investor purchases 2 ABC Mar 76 calls for 2.50. Which two of the following statements are TRUE?

I. The breakeven is 73.50
II. The breakeven is 78.50
III. The contract will be profitable if it expires
IV. The investor wants the contract to be exercised
A) I and IV
B) II and IV
C) I and III
D) II and III

Answer 11

Correct Answer:
B) II and IV

Answer Explanation
The breakeven of a call is the strike price + the premium. The buyer of a call will profit if the stock price is above the breakeven. Exercise of the contract allows the holder to buy stock at the strike price when the market price is higher. A call buyer loses the premium paid if the contract expires.

Textbook Reference
Please see textbook section 6.2.1

Question 12

Which of the following equity type instruments will give an investor the longest amount of exposure to the future price movements of the underlying common stock?
A) Convertible bond
B) LEAP
C) Stock rights
D) Traditional equity option contract

Answer 12

Correct Answer:
B) LEAP

Answer Explanation
A LEAP is a long-term equity option contract. This longer maturity, as compared to a traditional short-term contract, can provide an investor with exposure to the price movement of the underlying common stock for a greater period of time.

Textbook Reference
Please see textbook section 6.1.1.1

Question 13

An investor buys an S&P 500 2025 put for 15. Just prior to expiration the S&P is 1980. Which two of the following statements are TRUE?

I. The investor will exercise the contract
II. The contract will expire
III. The investor profits in this transaction
IV. The investor has a loss in this transaction
A) I and IV
B) II and III
C) II and IV
D) I and III

Answer 13

Correct Answer:
D) I and III

Answer Explanation
The investor paid $1,500 to purchase the index put. The put is exercised because the index value is below the exercise price. Index options settle in cash, so the holder realizes $4,500 (2025 – 1980 x 100 multiplier) at exercise. The investor’s profit on this transaction is $3,000 (Paid $1,500, received $4,500).

Textbook Reference
Please see textbook section 6.3.1.1

Question 14

An investor writes 2 ABC Mar 76 calls for 2.50. Which two of the following statements are TRUE?

I. The breakeven is 73.50
II. The breakeven is 78.50
III. The contract will be profitable if it expires
IV. The investor wants the contract to be exercised
A) II and IV
B) I and IV
C) II and III
D) I and III

Answer 14

Correct Answer:
C) II and III

Answer Explanation
The breakeven of a call is the strike price + the premium. The writer of a call will profit if the stock price is below the breakeven and the contract expires. The writer will keep the premium received and is not obligated to sell the stock.

Textbook Reference
Please see textbook section 6.2.2

Question 15

A customer buys 100 shares of XYZ stock for 57 and writes a 60 call for 4. The stock price rises to 65 and the option is exercised. The profit or loss to the investor is
A) Profit of $700
B) Loss of $400
C) Profit of $300
D) Loss of $100

Answer 15

Correct Answer:
A) Profit of $700

Answer Explanation
The stock is purchased for $5,700 and sold for $6,000. In addition, the customer received a premium of $400 for writing the call. The investor has a profit of $700.

Textbook Reference
Please see textbook section 6.2.2.2

Question 16

To reduce loss in a previously established position a call writer will engage in which of the following transactions?
A) Opening sale
B) Opening purchase
C) Closing purchase
D) Closing sale

Answer 16

Correct Answer:
C) Closing purchase

Answer Explanation
An investor that previously established a position by selling an option (writing a call or put) will close the position by purchasing an identical option to reduce or cancel the position.

Textbook Reference
Please see textbook section 6.7.1

Question 17

An investor bought a June 65 call when the stock price was $63. It will be exercised only if
A) the underlying stock is below $65 before expiration date.
B) the underlying stock is above $65 before expiration date.
C) the underlying stock is above $63 before expiration date.
D) the underlying stock is below $63 before expiration date.

Answer 17

Correct Answer:
B) the underlying stock is above $65 before expiration date.

Answer Explanation
Call options contracts are exercised only when they are in-the-money – i.e., the market value of the stock is above the strike price before expiration date.

Textbook Reference
Please see textbook section 6.2

Question 18

An investor that is short 100 shares of XYZ stock could best protect the stock position with which of the following?
A) Sell a put
B) Buy a put
C) Buy a call
D) Sell a call

Answer 18

Correct Answer:
C) Buy a call

Answer Explanation
An investor that has established a short stock position could best protect the position by purchasing a call. The call holder has the right to buy in the short stock position at the pre-determined exercise price of the call.

Textbook Reference
Please see textbook section 6.2.4

Question 19

An investor has purchased an ABC 93 call for 9. If ABC stock is trading at 88.50 just prior to expiration,
A) The investor will exercise the right to sell 100 shares of ABC for 93
B) The investor will exercise the right to buy 100 shares of stock at 88.50
C) The contract will expire and the investor will lose the premium
D) The investor will be obligated to sell 100 shares of ABC for 88.50

Answer 19

Correct Answer:
C) The contract will expire and the investor will lose the premium

Answer Explanation
An investor that has purchased a call has the right to buy stock at the exercise price if the contract is exercised. This contract will not be exercised because it is out of the money (the market price of 88.50 is below the strike price of 93; calls are in the money when the market price is above the strike price).

Textbook Reference
Please see textbook section 6.2.1.1

Question 20

An investor writes a 6-month XYZ 45 put for 4.75. Excluding commissions, this investor
A) Receives $475 for the put
B) Pays $475 for the put
C) Pays $450 for the put
D) Receives $450 for the put

Answer 20

Correct Answer:
A) Receives $475 for the put

Answer Explanation
An investor that writes puts receives a premium. The premium for a standard option contract is a price per share, and 100 shares are included in the contract. $4.75 x 100, or $475 is what this investor receives.

Textbook Reference
Please see textbook section 6.1.1.2

Question 21

An investor writes a call to increase income to his portfolio. In establishing this position this investor has engaged in an
A) Opening sale
B) Opening purchase
C) Closing sale
D) Closing purchase

Answer 21

Correct Answer:
A) Opening sale

Answer Explanation
This investor enters the market by writing a call. Creating an opening sale to establish the position.

Textbook Reference
Please see textbook section 6.7.1

Question 22

A customer sells short 100 shares of XYZ stock for 72 and buys one XYZ 75 call for 1.50. The stock price rises to 77 and the option is exercised. The profit or loss to the investor is
A) Profit of $450
B) Profit of $650
C) Loss of $450
D) Loss of $650

Answer 22

Correct Answer:
C) Loss of $450

Answer Explanation
The stock is sold short for $7,200. To protect the position the investor buys a call for $150. The call is exercised when the market price of the stock rises, so the investor buys the stock to cover the short position for $7,500. The customer received $7,200 from the short sale, but paid a total of $7,650 (premium + stock purchase price) for a loss of $450.

Textbook Reference
Please see textbook section 6.2.4

Question 23

Today, Vladimir sold 15 Landmark Inc. May 65 puts for 2.15. On settlement date, Vladimir
A) will receive a total of $3,225
B) will receive $2.15 per share when he delivers his Landmark shares to his broker-dealer
C) must pay a total of $3,225
D) must pay $65 per share

Answer 23

Correct Answer:
A) will receive a total of $3,225

Answer Explanation
Since Vladimir sold 15 put options for 2.15 each, he will receive a total of $3,225 in his account when this trade settles.

Textbook Reference
Please see textbook section 6.1.1

Question 24

Which two of the following options contracts are subject to automatic exercise at expiration if the market price of ABC is 45.25?

I. Long ABC 42 call
II. Long ABC 46 put
III. Long ABC 48 call
IV. Long ABC 44 put
A) I and IV
B) II and IV
C) I and II
D) II and III

Answer 24

Correct Answer:
C) I and II

Answer Explanation
The Options Clearing Corporation has provisions for the automatic exercise of certain in-the-money options at expiration. Generally, OCC will automatically exercise any expiring equity call or put in a customer account that is $0.01 or more in-the-money, and an index option that is $.01 or more in-the-money. Calls are in the money when the market price is higher than the exercise price; puts are in the money when the market price is lower than the exercise price.

Textbook Reference
Please see textbook section 6.6.1

Question 25

Just prior to expiration the market price of XYZ is stock is $63.27. If an investor holds an XYZ $63.25 put, which of the following statements is TRUE?
A) The put is subject to exercise but only if the investor gives written notice to the broker-dealer on the business day prior to expiration
B) Although the put is in the money, it does not meet the OCC rules of automatic exercise
C) The put will be exercised automatically and no notice is required
D) The put will expire

Answer 25

D) The put will expire

Answer Explanation
The Options Clearing Corporation will automatically exercise any expiring equity call or put in a customer account that is $0.01 or more in-the-money. No notice is required. Calls are in the money when the market price is higher than the exercise price; puts are in the money when the market price is lower than the exercise price. This put is not in the money and will expire.

Textbook Reference
Please see textbook section 6.6.1

Question 26

An investor has purchased an XYZ index 205 call for 4.75. Just prior to expiration, the index is 210. Which two of the following statements are TRUE?

I. The contract will be exercised
II. The contract will expire
III. holder will receive cash equal to the in-the-money amount
IV. holder will only pay the premium if the option is exercised
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 26

C) I and III

Answer Explanation
An investor that has purchased an index call has the right to exercise the contract for cash equal to the in-the-money amount. This contract will be exercised because the market price of the index is 210, which is above the strike price of 205; At exercise the holder will receive $500 (5 points in-the-money x multiplier of 100).

Textbook Reference
Please see textbook section 6.4

Question 27

An investor writes a December 50 call at 7 when the current market price of the stock is 46. Which of the following statements is true?
A) The contract has time value of $300
B) The contract has intrinsic value of $400
C) The contract has intrinsic value of $300
D) The contract has no intrinsic value

Answer 27

D) The contract has no intrinsic value

Answer Explanation
An option’s premium is comprised of time value and intrinsic value (the in-the-money amount of the contract). Calls have intrinsic value when the price of the stock is above the strike price. In this example, the premium is $700. The intrinsic value is $0 (the stock price is below the strike price), so the time value of the contract is $700, or the full amount of the premium.

Textbook Reference
Please see textbook section 6.5.1

Question 28

The option strategy presenting the greatest potential risk to an investor is a
A) Short call
B) Short put
C) Long put
D) Long call

Answer 28

A) Short call

Answer Explanation
The option strategy carrying the greatest potential risk is the short call. The risk on this trade could be unlimited.

Textbook Reference
Please see textbook section 6.2.2

Question 29

Which of the following is NOT TRUE about an investor that holds an equity LEAPS call contract?
A) They are subject to unlimited risk
B) Their options might have an expiration as long as three years
C) They may close out the position by selling it in the marketplace any time before expiration
D) Their contract performance is guaranteed by the OCC

Answer 29

A) They are subject to unlimited risk

Answer Explanation
A holder or buyer of an equity LEAP or equity option contract has maximum loss equal to the amount of the premium paid. Writers of call options are subject to unlimited risk.

Textbook Reference
Please see textbook section 6.2.1

Question 30

Two option contracts of the same issuer having the same exercise price will be priced differently owing to the different
A) Earnings potential of the two companies
B) Industries that the two companies are in
C) Expiration dates of the two contracts
D) Size of the two companies

Answer 30

C) Expiration dates of the two contracts

Answer Explanation
The element of time is a major factor in determining the value of an option premium. The option contract with the later expiration will have the higher premium, all other things being equal.

Textbook Reference
Please see textbook section 6.5.2

Question 31

An investor sells a call option for a premium of $3 and a strike price of $85. If the market value of the underlying stock is $83, the option has an intrinsic value of
A) $1.00
B) zero.
C) minus $5.
D) minus $2.

Answer 31

B) Zero

Answer Explanation
Intrinsic value is the amount an option is in-the-money, which is the current market value – strike price for calls and strike price – current market value for puts. If an option is out-of-the-money, as in this example, then intrinsic value is zero.

Textbook Reference
Please see textbook section 6.5.1

Question 32

Which of the following options strategies is considered mildly bullish?
A) Covered call
B) Uncovered put
C) Long put
D) Long call

Answer 32

A) Covered call

Answer Explanation
A covered call is a mildly bullish strategy because the investor wants to earn additional income from writing the call. If the price of the call increases too much, the investor will be forced to sell a stock at the strike price. A long call is the most bullish strategy. An uncovered put is also bullish because the investor will be forced to buy stock at the strike price unless the stock price falls. Long puts are bearish.

Textbook Reference
Please see textbook section 6.2.2

Question 33

Which two of the following options contracts are subject to automatic exercise at expiration if the market price of ABC is 45.25?

I. Long ABC 42 call
II. Long ABC 46 put
III. Long ABC 48 call
IV. Long ABC 44 put
A) II and III
B) I and II
C) II and IV
D) I and IV

Answer 33

B) I and II

Answer Explanation
The Options Clearing Corporation has provisions for the automatic exercise of certain in-the-money options at expiration. Generally, OCC will automatically exercise any expiring equity call or put in a customer account that is $0.01 or more in-the-money, and an index option that is $.01 or more in-the-money. Calls are in the money when the market price is higher than the exercise price; puts are in the money when the market price is lower than the exercise price.

Textbook Reference
Please see textbook section 6.6.1

Question 34

An investor is short an ABC Jan 65 put for a premium of 7. If at expiration the price of ABC is 53, which of the following statements is TRUE?
A) The holder of the contract will exercise the contract
B) The investor must deliver stock at expiration
C) The contract’s breakeven is 72
D) The contract is out-of-the-money at expiration

Answer 34

A) The holder of the contract will exercise the contract

Answer Explanation
A put is in-the-money whenever the price of the underlying stock is lower than the strike price. This contract is in the money, and profitable to the holder at expiration, because the breakeven is 58 (strike price minus premium for puts). The put holder will exercise the contract, and has the right to sell stock at 65. The writer (the party that is short) must buy it, when the current market price is actually 53. The loss to the writer is offset by the premium received.

Textbook Reference
Please see textbook section 6.3.2.1

Question 35

All of the following investors would benefit from the purchase of an S&P 500 put EXCEPT
A) An investor who wishes to generate portfolio income and believes that the market is likely to remain flat
B) An investor who wants to take advantage of the leverage that options can provide with a limited dollar risk
C) An investor who wants diversify a portfolio with downside exposure of the S&P 500, but does not wish to establish short positions in shares of multiple component issues
D) An investor who is highly bearish on the market overall and wants to profit from a decline in its level

Answer 35

A) an investor who wishes to generate portfolio income and believes that the market is likely to remain flat.

Answer Explanation
An Index put allows the investor to profit from a downward move in the level of the market as measured by S&P 500 index, while committing less capital compared to the margin requirements needed for the short sale of a number of component issues. A long put holder is not subject to the unlimited upside risk that applies to investors with short stock positions. The maximum loss to the investor is the premium paid.

Textbook Reference
Please see textbook section 6.4

Question 36

What is the best way to describe an investor’s profit potential when writing a call option?
A) It is limited to the premium received.
B) It is unlimited if the underlying stock increases.
C) It is significant if the underlying stock declines.
D) It is limited to the premium paid.

Answer 36

A) It is limited to the premium received

Answer Explanation
The maximum gain for the writer of an option is the premium received.

Textbook Reference
Please see textbook section 6.2

Question 37

An investor that purchases a put option while holding shares of the underlying stock is
A) Increasing profit on the stock position through the use of leverage
B) Limiting downside loss of unrealized gains from holding the stock
C) Mostly bearish on the underlying stock
D) Attempting to generate additional income on the stock that is owned

Answer 37

B) Limiting downside loss of unrealized gains from holding the stock

Answer Explanation
When an investor owns stock and then purchases a put, the investor is using the put to protect gains. This is known as a protective put strategy.

Textbook Reference
Please see textbook section 6.3.4

Question 38

Two weeks after purchasing a May 80 call option, the value of the underlying equity security is 95. In order to benefit from this situation, the investor
A) must allow the option to expire.
B) can either exercise the option or liquidate the position in the open market.
C) must exercise the option in order to realize a profit from this position.
D) must place an order to sell the underlying equity security.

Answer 38

B)

Answer Explanation
If an investor owns a call option which is “in-the-money” (has intrinsic value), the investor may choose to either exercise the option, or liquidate the position in the open market.

Textbook Reference
Please see textbook section 6.7.2

Question 39

In which two of the following options positions may an investor exercise the rights of the contracts?
I. Long call
II. Long put
III. Short call
IV. Short put
A) I and II
B) I and IV
C) II and III
D) II and IV

Answer 39

A) I and II

Answer Explanation
An investor that buys calls or puts owns the right to exercise the contract. Buying calls secures the right to buy stock at the strike price, while buying puts secures the right to sell stock at the exercise price.

Textbook Reference
Please see textbook section 6.1

Question 40

Which two of the following statements regarding exercise of index options is true?

I. Exercise settlement requires delivery of stock
II. Exercise settlement requires delivery of cash
III. Transactions are settled the business day following the trade
IV. Transactions are settled on the third business day after the trade
A) II and IV
B) I and IV
C) II and III
D) I and III

Answer 40

C) II and III

Answer Explanation
Index options are settled in cash equal to the in-the-money amount based on the closing value of the index. Cash settlement takes place on the business day following the settlement date.

Textbook Reference
Please see textbook section 6.4

Question 41

A client owns a portfolio of blue chip stocks that is to fund his retirement in 10 years. Although confident that the market will continue to advance, he is concerned that a market correction of more than 10% could wipe out significant value. Which of the following strategies might benefit this investor?
A) Sell index calls
B) Sell index puts
C) Buy index calls
D) Buy index puts

Answer 41

D) Buy index puts

Answer Explanation
By purchasing index puts the investor would earn cash in an overall market decline. This cash could offset portfolio losses and allow the investor to benefit from continued market growth from the blue chip portfolio.

Textbook Reference
Please see textbook section 6.4

Question 42

An investor sells short 200 shares of STP stock for $65 per share and later buys 2 STP 68 calls for 2 when the market price of STP is $64. Which two of the following are TRUE?

I. The investor’s breakeven is 63
II. The investor’s breakeven is 67
III. The investor’s maximum gain is unlimited
IV. The investor’s maximum loss is $1,000
A) II and III
B) I and IV
C) I and III
D) II and IV

Answer 42

B) I and IV

Answer Explanation
While a question such as this is unlikely on the SIE there are a couple of important takeaways.

Firstly, this is a 2-position options problem. Therefore: takeaway #1 is that “call-up” and “put-down” wont work for breakeven. Breakeven is therefore a little more annoying to calculate … but luckily there is a shortcut for this.
Notice that the investor is a) selling short a stock position while b) simultaneously opening up a call option on the same stock. This is a classic short-stock hedge.

Breakeven will be:
* Price at which the stock is shorted (less) Premium Paid for the call option.
* $65 - $2 = $63

At a high level what’s going on for breakeven is this: the investor pocketed $65 per share since they shorted the stock. They have that cash on hand. They also paid $2 per share for a call option.
If the stock dips down to $63, the investor can return the borrowed shares by buying back at $63 making a $2 difference on the short sale. $65 per share in cash (less) $63 to buy the shares back and return it to the original owner.
The $2 gain (on the short sale of the stock) subtracted from the $2 premium paid to own the call gives a total profit/loss of $0. Aka, breakeven.

Key takeaway #2: The more interesting point about a short-stock hedge is the fact that this options position will put a cap on the maximum loss that a short investor will potentially face by hedging the investors risk to the short stock.
For a short-stock hedge maximum loss will be: Strike of the call option (less) Short price of the stock plus Premium paid. As the explanation states below, “The most the investor can lose is limited by the purchase of the call, which allows the stock to be bought in at 68 if the market goes up”.
In other words, if you are short a stock you can buy a call option (the right to buy) at a specific strike (depends on your risk tolerance) that you can exercise in the event the market goes way up … add to that a premium (what you pay to own the option).

Note: all of the calculations above are on a per-share basis so when calculating max loss don’t forget to calculate the total for the entire position.
There are 200 shares at play here. A $5 max loss per share ($68 - $65 + $2) x 200 shares = $1,000 maximum loss.

Thus, answer choices I and IV are correct.

Please also reference the short hedge example in the Lesson 6: Options video lecture for an additional overview.

Textbook Reference
Please see textbook section 6.2.3

Question 43

An option strategy that may permit an investor to purchase stock and receive a premium is
A) Short calls
B) Long calls
C) Short puts
D) Long puts

Answer 43

C) Short puts

Answer Explanation
The sale of a put requires an investor to buy shares when assigned. Additionally, when writing a put, an investor earns the premium for selling the option.

Textbook Reference
Please see textbook section 6.3.2

Question 44

At exercise a customer is obligated to sell stock in which of the following positions?
A) Long call
B) Short call
C) Long put
D) Short put

Answer 44

B) Short call

Answer Explanation
Short options positions have obligations that must be performed if the holder exercises the contract. Call writers have the obligation to sell stock when the holder exercises the right to buy at the strike price.

Textbook Reference
Please see textbook section 6.1

Question 45

An investor purchases 100 shares of XYZ stock at 56 and later buys 1 XYZ 54 put for 2.10 when the market price of ABC is 55. What is the investor’s breakeven on the combined purchase?
A) 56.1
B) 51.9
C) 53.9
D) 58.1

Answer 45

D) 58.1

Answer Explanation
When an investor buys a put to protect a stock purchase, the investor will breakeven when the stock price is equal to the cost of the stock plus the put premium. 56 + 2.10 = $58.10.

Textbook Reference
Please see textbook section 6.3.4

Question 46

Which options strategy can allow an investor to purchase shares at a predetermined price that is lower than the current market price?
A) Buy a call
B) Write a put
C) Write a call
D) Buy a put

Answer 46

A) Buy a call

Answer Explanation
A long call allows an investor to exercise and buy shares at the strike price for stock that has increased in value.

Textbook Reference
Please see textbook section 6.3.2

Question 47

An investor is long an ABC Jan 65 put for a premium of 7. If at expiration the price of ABC is 53, which two of the following statements are TRUE?

I. The contract is profitable to the holder at expiration
II. The contract is in-the-money at expiration
III. The contract will not be exercised
IV. The contract’s breakeven is 72
A) II and IV
B) II and III
C) I and II
D) I and IV

Answer 47

C) I and II

Answer Explanation
A put is in the money whenever the price of the underlying stock is lower than the strike price. This contract is in the money, and profitable to the holder at expiration because the breakeven is 58 (strike price minus premium for puts). The put holder will exercise the contract, and has the right to sell stock at 65. The writer (the party that is short) must buy it, when the current market price is actually 53.

Textbook Reference
Please see textbook section 6.3.1.1

Question 48

A portfolio manager wants to hedge his long equity positions and increase the portfolio’s income. Which of the following strategies is appropriate?
A) Short index put
B) Long index call
C) Short index call
D) Long index put

Answer 48

C) Short index call

Answer Explanation
Income is achieved from writing options and receiving premiums. Short index calls provide some downside protection (the amount of premium received), and also increase the income to the portfolio.

Textbook Reference
Please see textbook section 6.4

Question 49

An investor wrote an XYZ index 205 put for 4.75. Just prior to expiration, the index is 210. Which two of the following statements are TRUE?

I. The contract will be exercised
II. The contract will expire
III. The holder will receive cash equal to the in-the-money amount
IV. The writer will keep the premium of $475
A) I and III
B) II and IV
C) II and III
D) I and IV

Answer 49

B) II and IV

Answer Explanation
An investor that has written an index put is obligated to pay cash equal to the in-the-money amount to the holder if the contract is exercised. Puts are in the money when the market value is below the strike price. This contract will expire because the market price of the index is 210, which is above the strike price of 205; At expiration of the contract the holder will lose the premium paid, but the writer will keep the premium of $475.

Textbook Reference
Please see textbook section 6.4

Question 50

An investor purchases 200 shares of STP stock for $64 per share and buys 2 STP 62 puts for 1.50 when the market price of STP is $65. What is the maximum loss?
A) $700
B) $350
C) unlimited
D) $450

Answer 50

A) $700

Answer Explanation
The investor loses money on the stock when the market price falls. But, the long put allows the investor to sell the stock at 62. Thus, the investor can lose $2 per share on the stock, plus the premium of $1.50 that was paid for a total of $3.50 per share. 200 shares x $3.50 = maximum loss of $700.

Textbook Reference
Please see textbook section 6.2.3

Question 51

A holder of a call option contract would like to receive a cash dividend declared by the issuer of the underlying stock. In order to receive the dividend, what action must the holder take?
A) The holder must exercise the option before the record date
B) The holder will receive the dividend automatically, and no action is required
C) The holder must exercise the option before the ex-dividend date
D) The holder is not entitled to receive the dividend under any circumstances

Answer 51

C)

Answer Explanation
Cash dividends are paid by issuers to owners of the stock as of the date of record. To receive a cash dividend, a call holder must exercise the option prior to the ex-date of the dividend. For an American-style call option, early exercise is possible and the investor needs to weigh whether the benefit of being long the underlying stock and receiving the dividend outweighs the cost of surrendering the option early. Typically, this makes sense only for call options that are deeply in the money before the dividend is paid.

Textbook Reference
Please see textbook section 6.7.3.2

Question 52

The type of call option that has unlimited potential for loss is
A) a covered call.
B) a short call.
C) a long call.
D) both a long call and a short call.

Answer 52

B) a short call

Answer Explanation
When an investor sells a call, they take on an obligation to sell the stock at the strike price. If the price of the stock rises, the investor will be forced to buy the stock in the market and then sell at the strike price. Because there is no limit to how high the stock can rise, the investor’s maximum loss is unlimited.

Textbook Reference
Please see textbook section 6.2.3

Question 53

If ABC stock is trading at $43.25 just prior to expiration, which of the following options positions will expire?
A) Long 42.75 call
B) Long 44.75 put
C) Short 42.75 put
D) Short 43 call

Answer 53

C) Short 42.75 put

Answer Explanation
Options expire when they are out of the money at exercise. A long or short call is in the money when the stock price is above the contract’s exercise price. A long or short put is in the money when the stock price is below the contract’s exercise price. The short 42.75 put is the only position that is not in the money.

Textbook Reference
Please see textbook section 6.3

Question 54

Which two of the following options strategies are bullish?

I. Long call
II. Short call
III. Long put
IV. Short put
A) I and III
B) I and IV
C) II and IV
D) II and III

Answer 54

B) I and IV

Answer Explanation
A bullish investor is profitable when market prices rise. Call buyers and put sellers are bullish. Call buyers have the right to buy at the exercise price, while put sellers are not assigned when market prices rise. They may keep the premium received without having to buy stock.

Textbook Reference
Please see textbook section 6.3.2

Question 55

An investor has purchased a call option on XYZ stock. Which two of the following statements are TRUE?

I. The contract is an American style contract
II. The contract could be either an American or European style contract
III. The contract may be exercised only at a specified time just prior to expiration
IV. The contract may be exercised any time after purchase but prior to expiration
A) I and III
B) II and IV
C) I and IV
D) II and III

Answer 55

C) I and IV

Answer Explanation
Options on stock, or equity options, are American style contracts only. This means that the holder may exercise them at any time after purchase but before the contract’s expiration date. Index options contracts are both American and European style.

Textbook Reference
Please see textbook section 6.1.1.1

Question 56

All of an issuer’s options that are the same type and share the same strike price and expiration month are called a(n)
A) Run
B) Issue
C) Series
D) Ladder

Answer 56

C) Series

Answer Explanation
There are two types of options: calls and puts. All of an issuer’s 35 April calls would be a series. The same issuer’s 35 April puts would be a separate series.

Textbook Reference
Please see textbook section 6.1.1

Question 57

Two options contracts would be in the same series when they have common
A) Expiration months and strike prices
B) Premiums and intrinsic values
C) Strike prices and premiums
D) Premiums and expiration months

Answer 57

A) Expiration months and strike prices

Answer Explanation
Two option contracts are in the same series because they have the same expiration month and strike price.

Textbook Reference
Please see textbook section 6.1.1

Question 58

An investor with no other positions sells 1 ABC Jan 50 call at 3.50. The call is exercised when the stock is trading for 55. What is the investors’ profit or loss?
A) Profit of $150
B) Loss of $150
C) Loss of $850
D) Profit of $850

Answer 58

B) Loss of $150

Answer Explanation
The investor received $350 from the sale of the call. The exercise of the call requires the investor to sell the stock at the strike price, so the writer makes $5,000. However the customer has to buy the stock so it’s available to sell (the investor had no other positions). Buying the stock at the current price of $5,500 results in a $150 loss. (Paid $5,500, received $5,350).

Textbook Reference
Please see textbook section 6.2.2.1

Question 59

An investor has purchased an ABC 67 put for 4. If ABC stock is trading at 68.50 just prior to expiration,
A) The contract will expire and the holder will lose the premium
B) The investor will be obligated to sell 100 shares of ABC for 67
C) The investor will have the right to buy 100 shares of stock at 67
D) The investor will exercise the right to sell 100 shares of ABC for 67

Answer 59

A)

Answer Explanation
An investor that has purchased a put has the right to sell stock at the exercise price if the contract is exercised. This contract will not be exercised because it is out of the money (the market price of 68.50 is above the strike price of 67; puts are in the money when the market price is below the strike price).

Textbook Reference
Please see textbook section 6.3.1.1

Question 60

An investor that is short 100 shares of XYZ stock could best protect the stock position with which of the following?
A) Sell a put
B) Buy a call
C) Sell a call
D) Buy a put

Answer 60

B) Buy a call

Answer Explanation
An investor that has established a short stock position could best protect the position by purchasing a call. The call holder has the right to buy in the short stock position at the pre-determined exercise price of the call.

Textbook Reference
Please see textbook section 6.2.4

Question 61

An investor establishes the following position:
Long 1 XYZ 50 put at 3.
All of the following statements about this contract are true EXCEPT
A) All XYZ puts with the same strike price and expiration date are included in the same series of options contracts
B) The investor holds the obligation to sell the stock
C) The investor has paid a premium to establish this position
D) It is part of a class of options contracts which includes all puts on XYZ stock

Answer 61

B)

Answer Explanation
An investor that establishes a long put position holds the right, not the obligation, to sell the stock at the strike price, and has paid a premium to acquire this right. A class of options is all calls or all puts on the stock of a particular issuer. A series of option contracts is all options of a given type (call or put) on the same stock, with the same strike price and expiration date.

Textbook Reference
Please see textbook section 6.1.1

Question 62

Today, Vladimir sold 15 Landmark Inc. May 65 puts for 2.15. On settlement date, Vladimir
A) must pay a total of $3,225
B) will receive $2.15 per share when he delivers his Landmark shares to his broker-dealer
C) must pay $65 per share
D) will receive a total of $3,225

Answer 62

D)

Answer Explanation
Since Vladimir sold 15 put options for 2.15 each, he will receive a total of $3,225 in his account when this trade settles.

Textbook Reference
Please see textbook section 6.1.1

Question 63

With the current level of the S&P 500 index at 1815.94, an investor buys a three-month SPX call option with a strike price of 1820 that is currently trading for 54.40. At expiration, the value of the index is 1850. Which two of the following statements are TRUE?

I. The investor will receive cash at expiration
II. The investor must pay cash at expiration
III. The breakeven is 1761.54
IV. The contract is in the money at exercise
A) II and IV
B) I and III
C) I and IV
D) II and III

Answer 63

C) I and IV

Answer Explanation
An SPX index call is in the money when the index value is above the strike price, as in this example. At expiration, the holder of the call receives cash equal to the intrinsic value. The breakeven is calculated by adding the premium to the index strike price. 1820 + 54.40 = BE of 1874.40. Although this contract was in the money, the investor did not profit because the index was not higher than the BE point at exercise.

Textbook Reference
Please see textbook section 6.4

Question 64

An investor writes an S&P 500 2020 call for 8.50. Just prior to expiration the S&P is 2004. Which two of the following statements are TRUE?

I. The contract will be exercised
II. The contract will expire
III. The investor profits in this transaction
IV. The investor has a loss in this transaction
A) I and III
B) I and IV
C) II and IV
D) II and III

Answer 64

D) II and III

Answer Explanation
The investor received $850 to write the index call. The call is not exercised because the index value is below the exercise price. The writer profits from the premium received at expiration as the contrast will expire unexercised.

Textbook Reference
Please see textbook section 6.4

Question 65

Clearing member firms that have been assigned exercise notice by the OCC, assign to their customers in what manner?
A) Random, FIFO or LIFO
B) Random or FIFO only
C) Random only
D) Random or LIFO only

Answer 65

B) Radom or FIFO only

Answer Explanation
When the OCC assigns exercise to a clearing member’s customers’ account, the clearing firm then assigns the exercise to one or more of its customers on a random or first-in, first-out (FIFO) basis to customers that hold short positions in that options series.

Textbook Reference
Please see textbook section 6.6.1

Question 66

An investor owns one XYZ 70 call, and a 7% stock dividend occurs. As the result of the dividend, the investor will have
A) two calls, each with a strike price of 65.42, each call for 100 shares.
B) two calls, each with a strike price of 35, each call for 100 shares.
C) one XYZ call for 107 shares with a strike price of 65.42.
D) one XYZ call for 93 shares with a strike price of 75.27.

Answer 66

C)

Answer Explanation
As the result of a stock dividend, a call option would be adjusted for a new number of shares (higher) and a new strike price (lower). Prior to the dividend, the value of the contract is $7,000 (100 shares x 70). Following the dividend, the new number of shares is 107 with an adjusted strike price of 65.42 ($7,000/107). Important to note that the total value of the contract does not change as the result of a stock dividend (or stock split).

Textbook Reference
Please see textbook section 6.7.3.3

Question 67

An investor is long 2 ABC June 70 puts at 4. If just prior to expiration ABC is trading for 62, which two of the following are TRUE?

I. The puts will be exercised
II. The puts will expire
III. The investor will purchase stock
IV. The investor will sell stock
A) I and III
B) II and III
C) II and IV
D) I and IV

Answer 67

D) I and IV

Answer Explanation
This put is in the money just prior to expiration because the market price of 62 is below the exercise price of 70. The investor will exercise the right to sell the stock for the exercise price of 70.

Textbook Reference
Please see textbook section 6.3.1.1

Question 68

An investor sells 2 put options on a stock currently valued at $72. The strike price of the option is $75, and the premium received is $7. The maximum loss on this position is
A) $13,000.00
B) $16,400.00
C) $15,800.00
D) $13,600.00

Answer 68

D) $13,600

Answer Explanation
When an investor sells a put option, maximum loss will occur if the stock falls to zero as the investor will be obligated to buy the stock at the strike price, even though the shares are worthless. For taking on this obligation, the investor does receive the premium. To calculate maximum loss subtract the premium from the strike price and then multiply by both the number of contracts and shares per contract. $75 – $7 = $68. 100 shares x 2 contracts x $68 = $13,600. For any question on put option maximum gain, loss or breakeven, ignore the market value of the underlying.

Textbook Reference
Please see textbook section 6.3.3

Question 69

When a stock index option is exercised,
A) all margin calls must be satisfied within 24 hours.
B) a specific securities transaction is effected to complete the exercise process.
C) the exercise settlement process always occurs within two business days.
D) the settlement of the process occurs in cash.

Answer 69

D)

Answer Explanation
The exercise of a stock index option is always handled in cash, never through a securities transaction. In contrast, the exercise of an equity option is handled through a separate securities transaction.

Textbook Reference
Please see textbook section 6.4

Question 70

Kyle has written 10 ABC May 20 puts @ .75, while ABC is trading at 20.25. The time value is
A) 0.75
B) 1
C) 0.5
D) 0.25

Answer 70

A) 0.75

Answer Explanation
These put options are out of the money, therefore the entire premium will constitute time value.

Textbook Reference
Please see textbook section 6.5.2

Question 71

An investor purchases 2 ABC Mar 76 calls for 2.50. Which two of the following statements are TRUE?

I. The breakeven is 73.50
II. The breakeven is 78.50
III. The contract will be profitable if it expires
IV. The investor wants the contract to be exercised
A) II and IV
B) II and III
C) I and III
D) I and IV

Answer 71

A) II and IV

Answer Explanation
The breakeven of a call is the strike price + the premium. The buyer of a call will profit if the stock price is above the breakeven. Exercise of the contract allows the holder to buy stock at the strike price when the market price is higher. A call buyer loses the premium paid if the contract expires.

Textbook Reference
Please see textbook section 6.2.1

Question 72

With the market price at $67.25 at expiration, a long XYZ 65 call will
A) Be exercised only if the counterparty to the contract has met the initial margin requirement for purchase of the stock
B) Be exercised only if the holder gives exercise instruction
C) expire
D) Be automatically exercised according to OCC provisions

Answer 72

D

Answer Explanation
The Options Clearing Corporation has provisions for the automatic exercise of certain in-the-money options at expiration. This procedure is also referred to as “exercise by exception.” Generally, the OCC will automatically exercise any expiring equity call or put in a customer account that is $0.01 or more in-the-money, and an index option that is $.01 or more in-the-money. However, the customer’s broker-dealer may have a different threshold for automatic exercise which may or may not be the same as the OCC’s.

Textbook Reference
Please see textbook section 6.6.1

Question 73

An investor with no other positions buys an ABC May 63 put at 6.25. The investor buys the stock in the market and exercises the put when the stock is trading for 52. What is the investor’s profit or loss?
A) Profit of $475
B) Profit of $1,725
C) Loss of $1,725
D) Loss of $475

Answer 73

a) Profit of $475

Answer Explanation
The investor paid $625 to purchase the put. The stock is purchased at the market price for $5,200. The exercise of the put permits the investor to sell the stock at the strike price, so the customer makes $6,300. The investor has a profit of $475 (Paid $5,825, received $6,300).

Textbook Reference
Please see textbook section 6.3.1.1

Question 74

When is the settlement date for physical delivery of stock when options have been exercised?
A) The 2nd business day after exercise
B) The 5th business day after exercise
C) The day of exercise
D) The 3rd business day after exercise

Answer 74

A) The 2nd business day after exercise

Answer Explanation
When options have been exercised, settlement date for physical delivery of stock is 2 business days after the exercise date.

Textbook Reference
Please see textbook section 6.7.3.1

Question 75

Whereas a regular stock transaction will settle two business days following the trade, an options transaction will settle
A) the next business day
B) also on the second business day following the trade
C) At any agreed upon date by the buyer and the seller
D) that same day

Answer 75

A) The next business day

Answer Explanation
Options transactions settle on the business day following the transaction.

Textbook Reference
Please see textbook section 6.7.3

Question 76

Miss Smith buys 1 ABC Jul 70 call at 2.50 when the market is at 71. As time passes, the market price of ABC remains stable at 71. The premium, therefore, will probably
A) go up
B) stay the same
C) go down
D) exhibit extreme volatility

Answer 76

C) go down

Answer Explanation
The premium is the sum of the time value and intrinsic value. As the market value of the security remains the same, the intrinsic value does not change. The time value decays as expiration approaches and the chance of the option moving deeper in the money decreases. Therefore, the premium as a whole also decreases.

Textbook Reference
Please see textbook section 6.5.2

Question 77

An investor writes 2 ABC Mar 76 calls for 2.50. Which two of the following statements are TRUE?

I. The breakeven is 73.50
II. The breakeven is 78.50
III. The contract will be profitable if it expires
IV. The investor wants the contract to be exercised
A) I and III
B) II and III
C) I and IV
D) II and IV

Answer 77

B) II and III

Answer Explanation
The breakeven of a call is the strike price + the premium. The writer of a call will profit if the stock price is below the breakeven and the contract expires. The writer will keep the premium received and is not obligated to sell the stock.

Textbook Reference
Please see textbook section 6.2.2

Question 78

An investor wishes to profit on her belief in a future deep overall market decline. Which of the following strategies is suitable?
A) Long index put
B) Short index put
C) Long index call
D) Short index call

Answer 78

A) Long index put

Answer Explanation
An investor that anticipates a substantial drop in the market overall can profit by buying an index put. If the market declines and the put is assigned, the writer will deliver cash equal to the in the money value. The sharper the market decline, the more the index put is in the money, providing a profit to the bigger of the put index.

Textbook Reference
Please see textbook section 6.4

Question 79

An investor has established the following position:

Buy 100 ABC at 76
Sell 1 ABC 80 call at 1.75.
At expiration ABC is 72. Which of the following best describes the impact to this investor?
A) The call will expire so the premium received will reduce the cost basis of the ABC stock to $74.25 per share
B) The counterparty will exercise the right to buy stock, so the investor will sell stock the stock at 80 and have a profit of $5.75 per share because of the premium received on the short call
C) The investor will keep the stock but lose the premium on the option that was written
D) The investor will be required to buy stock at 80, but the cost will be reduced by the premium received

Answer 79

A) The call will expire so the premium received will reduce the cost basis of the ABC stock to $74.25 per share

Answer Explanation
This is an example of covered call writing. When the call expires, the premium received on writing the call can reduce the price of the stock. Worst case, the investor would deliver the stock and profit on the difference between the stock price and the exercise price, plus the premium received.

Textbook Reference
Please see textbook section 6.2.2.2

Question 80

An investor writes 2 XYZ June 73 calls at 8. Just before expiration XYZ is trading for 66. Which of the following statements is TRUE?
A) The investor has a profit of $800
B) The investor receives 200 shares of stock at 73
C) The investor has a profit of $1,600
D) The investor is required to sell 100 shares of stock at 73

Answer 80

C) The investor has a profit of $1,600

Answer Explanation
This call is out of the money and will expire, so the writer is not obligated to sell the stock. The buyer will not exercise the right to buy stock at the strike price of 73 when it could be purchased on the market for 66. The writer profits from the premium of $1,600 received for writing 2 contracts at $800 each.

Textbook Reference
Please see textbook section 6.2.2.1

Question 81

A customer sells short 200 shares of XYZ stock for 43 and buys 2 XYZ 47 calls for 2.50. The stock price rises to 50 and the option is exercised. The profit or loss to the investor is
A) Loss of $1,300
B) Profit of $1,300
C) Profit of $650
D) Loss of $650

Answer 81

A) Loss of $1,300

Answer Explanation
The stock is sold short for $8,600. To protect the position the investor buys 2 calls for $500. The calls are exercised when the market price of the stock rises, so the investor buys the stock to cover the short position for $9,400. The customer received $8,600 from the short sale, but paid a total of $9,900 (premium + stock purchase price) for a loss of $1,300.

Textbook Reference
Please see textbook section 6.2.4

Question 82

The most profitable options strategy for an investor who believes that a stock will increase in value is a
A) short call
B) long put
C) covered call
D) long call

Answer 82

D) Long call

Answer Explanation
A long call is the most profitable options strategy for an investor to undertake if they believe that a stock will increase in value. There is unlimited potential profit available with a long call.

Textbook Reference
Please see textbook section 6.2.1

Question 83

All of the following are characteristics of listed options EXCEPT
A) Exchange trading
B) Fixed strike prices
C) Limited liquidity
D) Standardized expirations

Answer 83

C) Limited liquidity

Answer Explanation
Listed options are puts and calls that are exchange traded. They have standardized strike prices and expiration dates which make them marketable and liquid for buyers and sellers.

Textbook Reference
Please see textbook section 6.6.1

Question 84

Your customer owns ABC stock, but does not expect that the price will appreciate rapidly in the near future. To increase the income to his portfolio without adding significant risk, the customer should
A) Write ABC puts
B) Establish a married put strategy
C) Write calls on ABC stock
D) Buy ABC Leap calls

Answer 84

C) Write calls on ABC stock

Answer Explanation
By writing calls on stock that is owned, an investor receives a premium and is not obligated to sell the stock if the call is not exercised. The call writer wants little or no movement in the price of the stock so the obligation to sell it is not exercised by the holder.

Textbook Reference
Please see textbook section 6.2.2.2

Question 85

Which two of the following statements are true about the OCC?

I. It is the largest U.S. options exchange
II. It guarantees the performance of options contracts
III. It creates listed equity options and makes them available for trading
IV. It is a clearinghouse for equity options and derivatives
A) I and IV
B) II and IV
C) I and III
D) II and III

Answer 85

B) II and IV

Answer Explanation
The Options Clearing Corporation clears transactions in equity options and other derivative contracts. It guarantees the performance of options contracts that are assigned and executed by its clearing members

Textbook Reference
Please see textbook section 6.6.1

Question 86

An individual who writes an uncovered call option believes
A) That positive news will be forthcoming.
B) That the underlying stock price will rise above the strike price.
C) That the underlying stock price will fall below the strike price.
D) General stock market values will be very volatile in the coming weeks.

Answer 86

C)

Answer Explanation
The writer of an uncovered call believes that the market price of the underlying stock will remain below the strike of the option, thereby resulting in the option expiring and allowing the writer to retain the option premium.

Textbook Reference
Please see textbook section 6.2.2.1

Question 87

XYZ stock is trading at 21.75. The XYZ April 20 put option has time value
A) Equal to zero
B) Which cannot be determined
C) Equal to the intrinsic value of this option
D) Equal to the premium of this option

Answer 87

D) Equal to the premium of this option

Answer Explanation
An option premium is equal to its intrinsic value and its time value. If the option has no intrinsic value (as in this case), the premium is represented by time value only. A put option is said to be “in-the-money” (or have intrinsic value) when the market price of the underlying stock is below the strike price of the put. As this is not the case in this question, the put option is said to be “out-of-the -money”, and its premium is time value only.

Textbook Reference
Please see textbook section 6.5.2

Question 88

An investor buys a March 65 call, paying a premium of $3. This position will be profitable if
A) the option expires out-of-the-money.
B) the underlying stock is above $68.
C) the underlying stock is at $62 or above.
D) the underlying stock is at $65 or above.

Answer 88

B) the underlying stock is above $68

Answer Explanation
To determine profit in a long call, add the premium paid to the strike price. If the underlying stock rises above this level, the position is profitable.

Textbook Reference
Please see textbook section 6.2

Question 89

An investor sold short ABC stock at 35. In recent weeks the price of the stock has declined to 26. Which of the following would best protect the investor’s gain?
A) Long 28 call
B) Short 28 call
C) Short 25 put
D) Long 25 put

Answer 89

A) Long 28 call

Answer Explanation
An investor with a short stock position must eventually buy the stock to cover the short. The investor makes money if the stock can be bought at a lower price than the price at which it was sold. If the price has fallen since the short sale, the investor can buy a call that will lock in the price the investor will need to pay to buy in the position. A long call is the best protection for a short stock position.

Textbook Reference
Please see textbook section 6.2.4

Question 90

An investor buys an S&P 500 2015 call for 12.50. Just prior to expiration the S&P is 2025. Which two of the following statements are TRUE?

I. The investor will exercise the contract
II. The contract will expire
III. The investor profits in this transaction
IV. The investor has a loss in this transaction
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 90

A) I and IV

Answer Explanation
The investor paid $1,250 to purchase the index call. The call is exercised because the index value is above the exercise price. Index options settle in cash, so the holder makes $1,000 at exercise. Because the premium was $1,250, the investor loses money on this transaction (Paid $1,250, received $1,000).

Textbook Reference
Please see textbook section 6.2.1.1

Question 91

All of the following statements regarding premiums for index options are true EXCEPT
A) Premiums for index options are quoted in points and decimal amounts like equity options
B) The premium of an index option is comprised of intrinsic value and time value
C) The premium of an index put will generally increase as the level of the underlying index increases
D) An index premium point is ordinarily equal to $100

Answer 91

C)

Answer Explanation
Index options premiums are similar to equity option premiums. They are quoted in points and decimal amounts, and multiplier is ordinarily equal to $100, and premium components are intrinsic value (the in-the-money amount) and time value. The premium of a put on either an index option or an equity option increases as the underlying decreases in value.

Textbook Reference
Please see textbook section 6.4`

Question 92

All of the following statements regarding broad-based index options are true EXCEPT
A) Exercise settlement takes place in cash
B) They are usually more volatile than their individual stock components
C) Like equity options, the premium is comprised of time value and intrinsic value
D) The multiplier is typically 100

Answer 92

B)

Answer Explanation
Index options are usually less volatile than the individual stock components which are included within in them. This is because the ups and downs of individual stocks often cancel each other out in the computation of the index value.

Textbook Reference
Please see textbook section 6.4

Question 93

All of the following are objectives of call buyers EXCEPT
A) hedging a long stock position against falling prices
B) delaying a decision to buy stock
C) diversifying holdings
D) speculating for profit on the rise in price of stock

Answer 93

A)

Answer Explanation
Purchasing a call option does not hedge an investor with a long stock position, because if the stock goes down in value, the investor will lose money on the long position while the call option will expire worthless and offer no protection.

Textbook Reference
Please see textbook section 6.2.1

Question 94

An investor decides to purchase an XYZ 2-year 90 LEAPS call for a quoted price of $13. Which of the following statements is TRUE?
A) The contract controls 1000 shares of XYZ stock
B) The contract can only be exercised during a specified period just prior to its expiration
C) The holder is obligated to sell XYZ stock if the contract is exercised
D) The cost of the contract is $1,300

Answer 94

D) The cost of the contract is $1,300

Answer Explanation
A LEAPS call controls 100 shares of stock, and its premium must be multiplied by 100 to calculate the cost of the contract. The holder of an options contract has rights, not obligations. Equity LEAPS are American-style contracts, which means they can be exercised any time between the date of purchase and the expiration date.

Textbook Reference
Please see textbook section 6.1.1

Question 95

An investor sells a put option for a premium of $4. The strike price is $120. The investor’s breakeven is
A) $120.00
B) $128.00
C) $116.00
D) $124.00

Answer 95

C) $116.00

Answer Explanation
To calculate breakeven on a put, subtract the premium from the strike price. ($120 - $4 = $116.)

Textbook Reference
Please see textbook section 6.3.3

Question 96

An investor buys put options which have a maximum gain of $3,600 and a maximum loss of $550. What is the maximum gain and loss for the investor who sells this same trade?
A) $550 gain and unlimited loss.
B) It can’t be determined from the information given.
C) $3,050 gain and $4,150 loss.
D) $550 gain and $3,600 loss.

Answer 96

D) $550 gain and $3,600 loss

Answer Explanation
The maximum gain and maximum loss are exactly opposite for long and short puts since they are opposite sides of the same trade.

Textbook Reference
Please see textbook section 6.3.3

Question 97

An investor has written an ABC 60 put for 2. If ABC stock is trading at 53 just prior to expiration,
A) The contract will expire
B) The investor will be obligated to buy 100 shares of ABC for 60
C) The investor will have the right to buy 100 shares of stock at 60
D) The investor will have the right to sell 100 shares of ABC for 60

Answer 97

B)

Answer Explanation
An investor that has written a put is obligated to buy stock at the exercise price if the contract is exercised. This contract will be exercised because it is in the money (the market price of 53 is below the strike price of 60). Since only one contract was written, 100 shares must be purchased.

Textbook Reference
Please see textbook section 6.3.2.1

Question 98

Puts or calls of the same issuer share the same
A) Sub group
B) Series
C) type
D) Class

Answer 98

D) Class

Answer Explanation
Puts or calls of the same issuer are part of the same class.

Textbook Reference
Please see textbook section 6.1.1

Question 99

Which of the following terms is most interchangeable with “listed option”?
A) Standardized option
B) Customized option
C) OTC option
D) Exchange traded option

Answer 99

D) Exchange Traded Option

Answer Explanation
Listed options are puts and calls that are exchange traded. They have standardized strike prices and expiration dates which make them marketable and liquid for buyers and sellers.

Textbook Reference
Please see textbook section 6.6

Question 100

An investor writes a call to increase income to his portfolio. In establishing this position this investor has engaged in an
A) Opening sale
B) Closing purchase
C) Opening purchase
D) Closing sale

Answer 100

A) Opening Sale

Answer Explanation
This investor enters the market by writing a call. Creating an opening sale to establish the position.

Textbook Reference
Please see textbook section 6.7.1

Question 101

An investor has placed an order to write 10 put options on ABC stock. This would be the client’s initial option trade, after having previously done a few equity trades. The order ticket for the option trade would be marked
A) Opening sale
B) Opening purchase
C) Closing sale
D) Closing purchase

Answer 101

A) Opening Sale

Answer Explanation
Whenever an investor initially writes an option (E.g. sells a call or a put) that is referred to as an opening sale. If the investor then buys that option back, then it is a closing purchase.

Textbook Reference
Please see textbook section 6.7.1

Question 102

Which of the following investment strategies is least appropriate for retail investors?
A) Buying a call option
B) Selling a put option
C) Selling an uncovered option
D) Buying a put option

Answer 102

C) Selling an uncovered option

Answer Explanation
Retail investors are least likely to engage in call writing strategies, especially uncovered call option writing.

Textbook Reference
Please see textbook section 6.2.2.1

Question 103

Which of the following offers a leveraged alternative to a long position in stock?
A) Long put
B) Short put
C) Short call
D) Long call

Answer 103

D) Long call

Answer Explanation
A long call gives the investor the right to buy the underlying stock and allows an investor to benefit on its gains without having paid in full for the shares. The investor benefits from leverage, receiving a higher return for a dollar invested.

Textbook Reference
Please see textbook section 6.2.1

Question 104

To execute a covered call strategy, Jordan sells 28 call options. What is the minimum number of shares of stock she must own for the calls to be fully covered?
A) 560
B) 5,600
C) 280
D) 2,800

Answer 104

D) 2,800

Answer Explanation
Each listed option contract is for 100 shares. For a position to be fully covered, the underlying stock must fully collateralize the short call. For each option written, the investor must own 100 shares of stock. If any of this stock is sold, the position is no longer fully covered.

Textbook Reference
Please see textbook section 6.2.2.2

Question 105

All of the following are examples of derivative securities EXCEPT
A) Warrants
B) ETFs
C) Futures contracts
D) Swaps

Answer 105

B) ETFs

Answer Explanation
Options, futures contracts, swaps and warrants are common examples of derivative securities. The value of a derivative security is based on the underlying asset, which may be nearly any asset, including stock, debt securities or commodities. ETFs, or exchange traded funds, are like mutual funds, in that the investor owns a proportionate share of the underlying securities. Unlike mutual funds, ETF are exchange-traded and are not redeemed by the fund.

Textbook Reference
Please see textbook section 6.1

Question 106

An investor writes an XYZ June 102 put for 10. Just prior to expiration the price of XYZ is 103. Which two of the following statements are TRUE?

I. The contract will be exercised
II. The contract will expire
III. The investor profits in this transaction
IV. The investor has a loss in this transaction
A) I and IV
B) II and III
C) I and III
D) II and IV

Answer 106

B) II and III

Answer Explanation
The investor received $1,000 to write the XYZ put. The put expires because the stock price is not below the exercise price. Because the option expires, the writer’s profit is the amount of the premium received.

Textbook Reference
Please see textbook section 6.3.2.1

Question 107

To establish a short position in one XYZ two-year 90 LEAP puts at $13, an investor will
A) Receive $1,170
B) Receive $1,300
C) Pay $1,170
D) Pay $1,300

Answer 107

b) Receive $1,300

Answer Explanation
When establishing a short options position, an investor receives premium income. Like equity options, LEAP options are quoted in points. Each contract includes a $100 multiplier, so the premium is multiplied by $100 for each contract. In this example, the investor receives $1,300 to open the position ($13 x 100 x 1 contract).

Textbook Reference
Please see textbook section 6.1.1.2

Question 108

An investor is long 2 ABC June 70 calls at 4. If just prior to expiration ABC is trading for 73, which two of the following are TRUE?

I. The calls will be exercised
II. The calls will expire
III. The investor will purchase stock
IV. The investor will sell stock
A) I and III
B) I and IV
C) II and III
D) II and IV

Answer 108

A) I and III

Answer Explanation
Just prior to expiration, this call is in the money because the market price of 73 is above the exercise price of 70. The investor will exercise the right to buy 200 shares of stock for the exercise price of 70.

Textbook Reference
Please see textbook section 6.2.1.1

Question 109

An investor with no other positions sells 1 ABC Jan 72 call at 5.25. The call is exercised when the stock is trading for 80. What is the investors’ profit or loss?
A) Profit of $275
B) Loss of $275
C) Loss of $1,325
D) Profit of $1,325

Answer 109

B) Loss of $275

Answer Explanation
The investor received $525 from the sale of the call. The exercise of the call requires the investor to sell the stock at the strike price, so the investor makes $7,200. However, the investor has to buy the stock to have it available to sell (the investor had no other positions). Buying the stock at the current price of $8,000 results in a $275 loss. (Paid $8,000, received $7,725).

Textbook Reference
Please see textbook section 6.2.2.1

Question 110

Why would Zach not be interested in purchasing a call option?
A) To hedge a short stock position
B) To hedge a long stock position
C) As a relatively inexpensive way to control 100 shares of the underlying stock
D) To lock in a purchase price for the underlying stock

Answer 110

B) To hedge a long stock position

Answer Explanation
Zach would not purchase a call option to hedge a long stock position; he would purchase a put option for this purpose.

Textbook Reference
Please see textbook section 6.3.4

Question 111

Sal has written ten XYZ May 120 put options. At expiration, XYZ is trading at 122. Sal will
A) receive an exercise notice and collect $12,000 in cash proceeds
B) be required to purchase 1000 shares of XYZ at 122 per share
C) tender an exercise notice and make full payment for 1,000 shares of XYZ
D) realize a profit for writing the puts as these contracts will expire

Answer 111

D)

Answer Explanation
As these put options are out of the money, Sal will benefit since the contracts will expire and he will realize a profit through the captured premiums.

Textbook Reference
Please see textbook section 6.3.2.1

Question 112

An investor writes a June 63 put for 1.50. Which two of the following statements are TRUE?

I. The investor’s breakeven is 64.50
II. The investor’s breakeven is 61.50
III. The investor is bullish
IV. The investor is bearish
A) I and III
B) I and IV
C) II and III
D) II and IV

Answer 112

C) II and III

Answer Explanation
The breakeven for a long or short put option is the strike price minus the premium. 63 — 1.50 = 61.50 The put writer does not begin to lose money until after the price of underlying stock falls below this price. The writer of a put is bullish. If the market price of the stock goes up, the buyer of the put will not exercise the right to sell the stock.

Textbook Reference
Please see textbook section 6.3.2

Question 113

An investor purchases an index 452 call for a premium of 9. At expiration the index value is 471. Which two of the followings statements are TRUE?

I. The call is in the money at expiration
II. The breakeven of the contract is 463
III. The investor will receive $1,900 at exercise of the contract
IV. The investor will receive $1,000 at exercise of the contract
A) I and IV
B) II and III
C) II and IV
D) I and III

Answer 113

D) I and III

Answer Explanation
This long index call was in the money at expiration, so was exercised for cash equal to the intrinsic value. Because the multiplier is $100, the cash amount is $1,900 and settlement takes place the business day after exercise. The BE for this call is 461 (SP + prem).

Textbook Reference
Please see textbook section 6.4

Question 114

To execute a covered call strategy, Jordan sells 28 call options. What is the minimum number of shares of stock she must own for the calls to be fully covered?
A) 5,600
B) 280
C) 560
D) 2,800

Answer 114

D) 2,800

Answer Explanation
Each listed option contract is for 100 shares. For a position to be fully covered, the underlying stock must fully collateralize the short call. For each option written, the investor must own 100 shares of stock. If any of this stock is sold, the position is no longer fully covered.

Textbook Reference
Please see textbook section 6.2.2.2

Question 115

The settlement date for the purchase or sale of an options contract is the
A) third business day
B) next business day
C) same business day
D) second business day

Answer 115

B) next business day

Answer Explanation
Options transactions settle on the business day following the transaction.

Textbook Reference
Please see textbook section 6.7.3