Option Questions Flashcards
Buying a put on a stock position held long is a suitable strategy when the market is expected to: I rise sharply II fall sharply III be stable IV be volatile A I and III B I and IV C II and III D II and IV
The best answer is D. Buying a put allows the holder to sell a security at a fixed price. Thus, it protects the owner of the underlying stock position in a falling market.
Which of the following option positions is used to hedge a long stock position?
A long call
B short call
C long put
D short put
The best answer is C.
Buying a put allows the owner of stock to sell it a fixed price (strike price) if the market falls. This limits downside risk on the long stock position.
A customer buys 100 shares of ABC at $87 and buys 1 ABC Jan 85 Put @ $4. ABC goes to $72 and the customer exercises the put. The customer’s loss is:
A $400
B $600
C $1,500
D $1,900
The best answer is B.
The customer buys the stock at $87 and sells it for $85 by exercising the put for a $2 loss. She paid $4 per share in premiums for the put contract, so the total loss is $6 points.
A customer buys 100 shares of XYZ at $74 and buys 1 XYZ Jan 75 Put @ $6. Just prior to expiration, the stock is trading at $72. The customer closes the option position at a premium of $2. One week later, the stock moves to $79 and the customer sells the stock position in the market. The net gain or loss on all transactions is:
A $100 loss
B $100 gain
C $200 gain
D $600 loss
The best answer is B.
The put contract was purchased at $6 and closed (sold) at $2 for a net loss of $4. The stock was purchased at $74 and sold at $79 for a net gain of $5. The net of all transactions is a 1 point or $100 gain.
A customer who is short stock will buy a call to:
A hedge the short stock position in a falling market
B protect the short stock position from a falling market
C protect the short stock position from a rising market
D generate additional income in a stable market
The best answer is C.
A customer who has shorted stock is bearish on the market. However, the potential loss for a short seller of stock is unlimited if the market should rise, forcing the customer to replace the borrowed shares at a much higher price. To limit this risk, the purchase of a call allows the stock position to be bought at a fixed price (by exercising the call), if needed, in a rising market.
On the same day in a margin account, a customer sells short 100 shares of ABC at $44 and buys 1 ABC Jan 45 Call @ $2.50. If the market price of ABC rises to $50 and the customer exercises the call, the result is a:
A $100 loss
B $250 loss
C $350 loss
D $500 loss
The best answer is C.
If the market price rises to $50, the customer exercises the call and buys in the stock at the $45 strike price. Thus, the customer sells the stock at $44, and buys it back at $45, for a 1 point loss on the stock. In addition, the customer loses the 2.50 point premium paid for the call. The total loss is 3.50 points or $350.
A customer sells short 100 ABC at $43 and buys 1 ABC Jan 45 Call @ $5. ABC goes to $33 and the customer lets the call expire and closes out the stock position at the market. The customer has a:
A $500 loss
B $500 gain
C $700 gain
D $1,000 gain
The best answer is B.
The customer has sold short shares of stock at $43 thinking that the market is going to go down. To protect his stock position from going up, the customer buys a call as well (which allows him to buy the stock at the strike price, if needed, in a rising market). Here, the market does what the customer wants it to do and goes down. As the market goes down, the call contract will expire “out the money.” The stock that was sold for $43 can be purchased in the market for $33 and replaced, for a 10 point gain. However, since $5 was paid in premiums for the call, the net gain is $5 per share or $500.
On the same day in a margin account, a customer sells short 100 shares of ABC at $46 and buys 1 ABC Jan 45 Call @ $2.50. The customer will break even at:
A $20.50 per share
B $43.50 per share
C $47.50 per share
D $48.50 per share
The best answer is B.
The customer has sold short the stock at $46, hoping to profit if the price should fall. As a hedge, the customer bought the call option to buy in the stock at a price of $45 if the market should rise. This protects the short stock position from unlimited upside loss potential. Since the customer sold the stock at $46 and paid $2.50 for the call option, the customer has a net sale amount of $43.50. To break even, the customer must buy back the stock at $43.50 per share.
A customer sells short 100 shares of ABC stock at $41 and buys 1 ABC Mar 40 Call @ $5. The maximum potential gain is:
A $3,500
B $3,600
C $4,100
D $4,600
The best answer is B.
If the stock falls, the customer gains on the short stock position. The customer sold the stock for $41. If it falls to “0,” the customer can buy the shares for “nothing” to replace the borrowed shares sold and make 41 points. The customer lets the call expire “out the money” losing 5 points, so the maximum potential gain is 36 points = $3,600.
A customer sells short 100 shares of PDQ at $58 and buys 1 PDQ Jul 60 Call @ $3. The customer’s maximum potential loss is:
A $200
B $300
C $500
D unlimited
The best answer is C.
The long call allows the customer to buy in the stock position at $60. Since the stock was sold at $58, exercise results in a net loss of $2 on the stock. The customer paid $3 for the call, so the total loss is $500.
A customer sells short 100 shares of ABC at $36 and buys 1 ABC Jul 35 Call @ $3. The stock falls to $30 and the customer closes the option contract at $1 and buys the stock at the current market price. The customer has a:
A $200 loss
B $300 loss
C $300 gain
D $400 gain
The best answer is D.
The customer sold the stock for $36 and bought a call, paying a premium of $3 per share, for net proceeds of $33. The customer closes the positions by purchasing the stock at $30 and selling the call contract for $1, for a net payment of $29 per share. The net profit is $33 - $29 = $4 or $400 on 100 shares.
On the same day, a customer buys 100 shares of ABC at $25 and sells short 100 shares of XYZ at $35. The customer then buys 1 ABC Jan 25 Put @ $4 and 1 XYZ Jan 35 Call @ $6. XYZ rises to $42 and the customer exercises the call. ABC falls to $19 and the customer exercises the put. The net gain or loss on all transactions is:
A $200 loss
B $1,000 gain
C $1,000 loss
D breakeven
c 1,000 loss
Long the stock and short the call is an appropriate strategy in a:
A declining market
B rising market
C stable market
D fluctuating market
The best answer is C.
Whenever a customer has a stock position, and the customer wishes to generate extra income by selling an option against that position, the market sentiment is neutral. This is a covered call writer - a call writer who owns the underlying stock position. The customer sells the call contract to generate extra income from the stock during periods when the market is expected to be stable. If the customer expects the market to rise, he or she would not write the call against the stock position because the stock will be “called away” in a rising market. If the customer expects the market to fall, he or she would sell the stock or buy a put as a hedge.
A customer buys 100 shares of ABC stock which is trading at $55. Subsequently, the market moves to $60. The customer thinks the market will remain at $60 in the following months, so he sells 1 ABC Sept 60 Call @ $3. ABC then goes to $58 and the customer’s call contract expires and the customer decides to liquidate his stock position at the current market price. The customer has a:
A $300 loss
B $300 gain
C $600 loss
D $600 gain
The best answer is D.
The customer bought the stock at $55 and sells it at $58 for a $3 gain. However, he also sold the call at $3. The aggregate gain on both transactions is +$3 + $3 = $600 gain.
A customer buys 100 shares of ABC stock at $40 and sells 1 ABC Jan 45 Call @ $2 on the same day in a cash account. The customer’s maximum potential gain until the option expires is:
A $200
B $500
C $700
D unlimited
The best answer is C.
If the market rises above $45 the short call will be exercised. The customer must deliver the stock that he bought at $40 for the $45 strike price, resulting in a $500 gain. Since $200 was collected in premiums, the total gain is $700. This is the maximum potential gain while both positions are in place.
What is the maximum potential loss for a customer who is long 100 ABC at $39 and short 1 ABC Jan 40 Call at $5?
A $500
B $600
C $3,400
D $3,900
The best answer is C.
This is a covered call writer. The maximum potential loss occurs when the market for ABC goes to zero. If it does, the customer loses $3,900 on the stock position, however, the customer received $5 in premiums for the now worthless call contract. The net maximum loss is $3,400. If the market rises, the call will be exercised and the customer will be obligated to sell stock at $40 that was purchased for $39. In addition to the $1 stock profit, the customer earns the premium of $5, for a total profit of $6 per share.
A customer buys 100 shares of ABC stock at $62 and sells 1 ABC Jan 65 Call @ $3. Prior to expiration, the customer closes the short call position at $4. The customer retains the long stock position. The gain or loss on the option is:
A $100 loss
B $300 loss
C $300 gain
D $700 loss
The best answer is A.
The short call was opened at $3 and closed with a purchase at $4 for a net loss of 1 point or $100 for the contract.
An options strategy where the maximum potential loss is equal to the difference between the value of the underlying long securities position and premiums received is a:
A naked call writer
B covered call writer
C naked put writer
D covered put writer
The best answer is B.
A covered call writer sells a call contract against the underlying stock that is owned by that customer. If the market drops, the call expires unexercised and the customer keeps the premium. However, as the market drops, the customer loses on the long stock position. Thus, the maximum potential loss is the full value of the stock position, net of collected premiums.
18 months ago, a customer purchased 100 shares of ABC stock at $32 in a cash account. It is now January and the stock is now trading at $50. The customer believes that the stock will continue to appreciate in the next 6 months to $55 per share, at which point no further appreciation is expected. The customer wishes to maximize the return on this stock with the smallest capital commitment. If the customer sells 1 ABC Jul 55 Call @ $3, the breakeven point will be:
A $29 per share
B $47 per share
C $53 per share
D $57 per share
The best answer is A.
This customer bought the stock at $32 per share. The customer sold an ABC Jul 55 Call, receiving a premium of $3 per share. This reduces the customer’s cost per share to $32 - $3 = $29. This is the breakeven point. The fact that the stock has appreciated has no effect on the breakeven comPutation.
Selling a put against a stock position sold short is a suitable strategy when the market is expected to:
A remain stable
B rise sharply
C fall sharply
D fluctuate sharply
The best answer is A.
Selling stock short alone is a bearish position. Selling a put alone is neutral or bullish strategy. Selling a put against a short stock position is a neutral strategy (as is any income strategy). If the stock is sold short and a put is sold with the same strike price, then if the market stays the same, the put expires “at the money” and the premium collected is retained. If the stock falls, the short put is exercised, obligating the customer to buy the stock at the same price at which it was sold. In this case, only the premium is earned. If the put had not been sold, then the customer would have had an increasing gain on the short stock position as the market fell - so he does not make as much in a falling market. On the other hand, if the market rises, the short put expires “out the money” and the customer is exposed to unlimited upside risk on the short stock position that remains.
A customer sells short 100 shares of ABC stock at $60 and sells 1 ABC Oct 60 Put @ $6. The market rises to $68 and the put expires. The customer buys the stock in the market covering his short stock position. The gain or loss is:
A $200 gain
B $200 loss
C $600 gain
D $600 loss
The best answer is B.
If the market rises, the short put expires. Here, the customer buys the stock at $68 to cover his short stock position that was originally sold at $60. There is an 8 point or $800 loss, that is partially offset by the $600 in premiums received. Thus, there is a net loss of $200.
A customer sells short 100 shares of ABC stock at $60 and sells 1 ABC Oct 60 Put @ $6. The market falls to $30 and the put is exercised. The gain or loss is:
A $600 gain
B $600 loss
C $2,400 gain
D $2,400 loss
The best answer is A.
If the market drops, the short put is exercised and the customer must buy the stock at $60. She can use this stock to replace the borrowed shares sold (short) at $60. There is no gain or loss on the stock. Since $600 was collected in premiums for selling the put, this is the gain.
A customer sells short 100 shares of PDQ at $47 and sells 1 PDQ Sep 50 Put @ $6. The breakeven point is:
A $55
B $53
C $47
D $41
The best answer is B.
The customer sold the stock at $47 and received $6 in premiums for selling the put, collecting $53 in total.
A customer sells short 100 shares of PDQ at $49 and sells 1 PDQ Sep 50 Put @ $6. The maximum potential gain while both positions are in place is:
A $500
B $600
C $700
D unlimited
The best answer is A. If the market falls, the short put is exercised and the stock must be bought at $50. Since it was already “sold” at $49, there is a loss of $1 per share ($100 total). But the customer collected $600 in premiums; so the end result is a net gain of $500. This is the maximum potential gain. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.
A customer sells short 100 shares of DEF stock at $62 and sells 1 DEF Oct 60 Put @ $6. The maximum potential gain while both positions are in place is:
A $800
B $4,400
C $5,400
D unlimited
The best answer is A.
If the market drops, the short put is exercised and the customer must buy the stock at $60. Since the stock was sold at $62, the customer gains 2 points, in addition to collecting 6 points of premiums. Thus, the maximum gain is $800. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.
A customer sells short 100 shares of ABC stock at $62 and sells 1 ABC Oct 60 Put @ $6. The maximum potential loss is:
A $600
B $5,600
C $6,000
D unlimited
The best answer is D.
If the market rises, the short put expires and the short stock position must be covered by making a purchase in the market. The loss potential is unlimited.
A customer sells short 100 ABC @ $35 and sells 1 ABC Jan 35 Put @ $3. The customer would NOT make money if the market price for ABC was at:
A $30
B $35
C $37
D $40
The best answer is D.
A customer with a short stock / short put position loses if the market rises. The customer sold the stock at $35 and collected $3 in premiums, for a total of $38. To break even, the stock must be bought for this amount. If the stock is bought for more than $38, the customer loses. Therefore, a loss is experienced at $40. To summarize, the formula for breakeven for a short stock / short put position is:
A customer owns ABC stock, purchased at $50 per share, and believes that the market can decline to $45 per share. The customer wishes to generate extra income from the stock position, but also wishes to protect the position from a large downside movement. The customer should:
A Sell an ABC 50 Call and buy an ABC 45 Put
B Buy an ABC 45 Put
C Buy an ABC 50 Call and buy an ABC 45 Put
D Sell an ABC 45 Call
The best answer is A.
This customer has a stock position from which he wishes to generate income - therefore the sale of a covered call is appropriate. In addition, he wishes to protect against the possibility of a sharp downward price movement giving him a loss on the stock. For this, the purchase of a put option is appropriate, allowing the customer to “put” the stock if the market price should decline sharply. The customer has placed a “collar” on the stock position.
A customer who is long 1 ABC Jan 40 Call wishes to create a “long call spread.” The second option position that the customer must take is:
A short 1 ABC Jan 30 Call
B short 1 ABC Jan 30 Put
C short 1 ABC Jan 50 Call
D short 1 ABC Jan 50 Put
The best answer is C. A spread is a buy and a sell of the same type of option. Since the customer is already long a call, he or she must be short a call to create a spread. In order for the position to be a “long call spread,” the customer must be a net buyer, meaning he or she must purchase the more expensive contract and sell the less expensive one. Since the lower strike price contracts are worth more money (for calls, since it is more advantageous to buy cheaper), he must sell the higher strike price contract to be a net buyer of the position. In this case, since the customer is already long a Jan 40 Call, to create a spread, a higher strike price call must be sold - and the only choice given that meets this criteria is to sell a Jan 50 Call. This is a moderately bullish strategy.
On the same day, a customer sells 1 ABC Jan 50 Call @ $2 and buys 1 ABC Jan 35 Call @ $8 when the market price of ABC is 41. The maximum potential gain is:
A $200
B $400
C $900
D unlimited
The best answer is C. The customer has created a long call spread.
Buy 1 ABC Jan 35 Call @ $8
Sell 1 ABC Jan 50 Call @ $2
$6 Debit
If the market rises above $50, both contracts are “in the money” and are exercised. This results in the stock being bought at $35 and sold at $50 for a 15 point profit. Since the debit paid is $6, the maximum potential gain is: 15 - 6 = 9 points or $900.
A customer buys 1 ABC Jan 100 Call @ $8 and sells 1 ABC Jan 120 Call @ $3 when the market price of ABC is $105. The maximum potential loss is:
A $300
B $500
C $1,500
D unlimited
The best answer is B.
The customer has purchased a long call spread. The positions are:
Buy 1 ABC Jan 100 Call @ $8
Sell 1 ABC Jan 120 Call @ $3
$5 Debit
If the market falls below $100, both calls expire “out the money” and the customer loses the net 5 points paid in premiums.
