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Unit 3 Flashcards

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1
Q

Who is a BUYER and who is a SELLER in terms of a DERIVATIVE?

A

The BUYER has the right to TAKE AN ACTION (buy or sell) the UNDERLYING ASSET from the SELLER.

In some DERIVATIVE CONTRACTS (futures), the BUYER will be OBLIGATED TO BUY THE ASSET on a SPECIFIC DATE.

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2
Q

What are DERIVATIVES normally USED FOR?

A

Derivatives are often used for COMMODITIES, such as

oil, gasoline, or gold (these are called FUTURES).

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3
Q

What are FUTURES in terms of DERIVATIVES?

A

Futures are DERIVATIVES that have a COMMODITY as the UNDERLYING ASSET.

Futures are NOT classified as securities.

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4
Q

What is a DERIVATIVE?

A

Is a CONTRACT that DERIVES ITS VALUE from an UNDERLYING ASSET.

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5
Q

A customer of a BD is OPENING A NEW OPTIONS ACCOUNT. The customer must RETURN THE OPTIONS AGREEMENT

A. signed before the account can be approved.
B. before the first transaction can occur.
C. signed and not later than 15 days after the account approval.
D. before he will be allowed to view the options disclosure document.

A

C. SIGNED and NOT LATER than 15 days AFTER the account approval.

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6
Q

Regarding ASSIGNMENT OF EXERCISES NOTICES, which of the following are TRUE?

I. The Options Clearing Corporation (OCC) assigns short BDs randomly.
II. The OCC assigns short BDs using the first-in, first-out (FIFO) accounting method.
III. Short BDs can assign their short customers randomly only.
IV. Short BDs can assign their short customers randomly, using the FIFO accounting method or by any other fair method.

A. l and III
B. I and IV
C. II and III
D. II and IV

A

B. I and IV

I. The Options Clearing Corporation (OCC) assigns short BDs randomly.
IV. Short BDs can assign their short customers randomly, using the FIFO accounting method or by any other fair method.

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7
Q

Describe an OPTION

A

is a TWO-PARTY CONTRACT, meaning that there are two parties involved in the contract—one party has the right to EXERCISE THE CONTRACT to buy or sell the UNDERLYING SECURITY, and the other is OBLIGATED TO FULFILL the terms of the contract.

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8
Q

LISTED OPTIONS TRANSACTIONS settle REGULAR WAY

A. on the third Friday of the expiration month.
B. on the next business day after trade date (T+1).
C. on the third business day after trade date (T+3).
D. when the option finally expires.

A

B. on the NEXT BUSINESS DAY after TRADE DATE (T+1).

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9
Q

What is the PRIMARY FUNCTION of the OCC?

A

Its primary functions are to

STANDARDIZE,
GUARANTEE THE PERFORMANCE OF, and
ISSUE OPTION CONTRACTS.

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10
Q

What is a CONTRACT PREMIUM?

A

The AMOUNT PAID for the contract when PURCHASED, or RECEIVED for the contract when it is SOLD

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11
Q

Who is the OCC?

A

OPTIONS CLEARING CORPORATION

The CLEARING AGENT for LISTED OPTIONS CONTRACTS—that is, those LISTED FOR TRADING on U.S. options exchanges.

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12
Q

What is the PURPOSE of the OCC?

A

Determines when NEW OPTION CONTRACTS should be OFFERED TO THE MARKET on an UNDERLYING SECURITY.

It designates the CONTRACT SPECIFICATIONS, such as STRIKE PRICES and EXPIRATION MONTHS for new contracts, utilizing standards to maintain UNIFORMITY AND LIQUIDITY.

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13
Q

True or False
OPTIONS CONTRACTS are traded WITHOUT A CERTIFICATE.

An investor’s PROOF OF OWNERSHIP is the TRADE CONFIRMATION.

A

True

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14
Q

What is meant by OPTIONS ARE DERIVATIVE SECURITIES?

A

This means that they DERIVE THEIR VALUE from that of an UNDERLYING INVESTMENT, such as:

a stock,
stock index,
interest rate,
or foreign currency.

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15
Q

Who is the BUYER

A

The buyer (owner of the contract) who pays the premium for the contract is often called the OWNER, the HOLDER, or the PARTY WHO IS LONG THE CONTRACT.

The buyer has the RIGHT TO EXERCISE the contract.

Buyers RISK LOSING THE PREMIUM PAID for the contract if the OPTION EXPIRES AS WORTHLESS.

Buyers begin the process with an OPENING PURCHASE of the contract.

If they decide to SELL THE CONTRACT LATER, the SECOND TRANSACTION is called a dosing sale.

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16
Q

What are some STANDARDS AND CHARACTERISTICS of LISTED OPTION CONTRACTS?

A 
■ Trading times
■ Settlement
■ Expiration
■ Exercise
■ Automatic exercise
■ Assignment
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17
Q

explain trading times for options

A

Listed options trade from 9:30 am to 4:00 pm ET.

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18
Q

The OWNER OF A CALL (party long the contract) has the RIGHT to

A

BUY THE STOCK at the STIKE PRICE

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19
Q

who is the SELLER?

A

The seller (writer of the contract) who RECEIVES THE PREMIUM FOR THE CONTRACT is called the WRITER or PARTY WHO IS SHORT THE CONTRACT.

The SELLER will be OBLIGATED TO PERFORM to if the BUYER chooses to EXERCISE THE CONTRACT.

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20
Q

A security that is a contractual obligation between two parties and whose VALUE is BASED ON THE SPECIFICS OF THE CONTRACT IN RELATION TO A DIFFERENT SECURITY

A. a contractual plan.
B. an investment company.
C. a derivative.
D. a hedge fund.

A

C. a derivative.

A contract that derives its value from its relationship to another security is a derivative. A contractual plan is a type of investment company that is no longer issued.

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21
Q

Which of the following statements regarding options are true?

I. Investors who are bullish on a stock should buy calls.
II. Investors who are bullish on a stock should buy puts.
III. investors who are bearish on a stock should sell puts.
IV. Investors who are bearish on a stock should buy puts.

A. I and IV
B. l and III
C. II and III
D. II and IV

A

A. I and IV

I. Investors who are BULLISH ON A STOCK should buy CALLS.

IV. Investors who are BEARISH ON A STOCK should buy PUTS.

BUYING CALLS is BULLISH and BUYING PUTS is BEARISH.

BUYING PUTS is BEARISH and SELLING PUTS is BEARISH.

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22
Q

Your customer, Mr. Newsome, recently purchased ONE PUT CONTRACT on Napa Valley Spirits, inc., stock.

The strike price is $50 and the premium was $4.50. tie later executed the contract.

How much did he PAY for the contract?

A. $5.000
B. $500
C. $4,550
D. $450

A

D. $450

The question asks WHAT HE PAID FOR THE CONTRACT, NOT WHAT HE RECEIVED when he executed it or the breakeven price.

One contract of 100 shares at $4.50 a share is $450.

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23
Q

What are equity options?

A

The most familiar options are those issued on common stocks

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24
Q

In theory, options can be created on

A

any item with a fluctuating market value

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25
What are the four basic transactions are available to an option investor.
I. Buy calls 2. Sell calls 3. Buy puts 4. Sell puts
26
What are the two types of option contracts?
calls and puts
27
Describe calls
An investor may buy calls (go long) or sell calls (go short).
28
Describe long call (purchase)
A call buyer owns the right to buy 100 shares of a specific stock at the strike price before the expiration if he chooses to exercise the contract. Therefore, a call buyer is a bullish investor (one who anticipates that the price of the underlying security will rise).
29
When is a call writer bearish investor ?
because he wants the market to fall (or remain unchanged). The contract is not exercised if the market price is below the strike price.
30
When is a call buyer bullish investor?
because he wants the market to rise. The call is exercised only if the market price rises above the strike price.
31
What is VIX option
designed to measure expected volatility of the U.S. stock market and is based on pricing from the S&P 500 Index. Investors use these options to speculate on volatility of the equity markets.
32
What is another name for the VIX option and why is it given that alternate name?
The VIX Index is often called the fear index, and tends to spike upward when the stock market experiences a severe downdraft. VIX options settle in cash with European exercise provisions.
33
Long 1 XYZ Jan 60 Call at 3. Explain each and what is he total premium?
Long The investor has bought the call and has the right to exercise the contract. XYZ The single contract represents 100 shares of XYZ stock. Jan The contract expires on the third Friday of January at 11:59 pm ET. 60 The strike price of the contract is 60. Call The type of option is a call, and the investor has the right to buy the stock a: 60 because he is long the call 3 The premium of the contract is $3 per share. Contracts are issued with 100 shares, so the total premium is 5300. The investor paid the premium to buy the call
34
What is short call?
A call writer (seller) has the obligation to sell 100 shares of a specific stock at the strike price if the buyer exercises the contract.
35
Explain Short 1 XYZ Jan 60 Call at 3 and what is the total premium?
Short The investor has sold the call and has obligations to perform if the contract is exercised. XYZ The single contract represents 100 shares of XYZ stock. Jan The contract expires on the third Friday of January at 11:59 pm . If expiration occurs, the writer keeps the premium without any obligation. 60 The strike price of the contract is 60. Call The type of option is a call, and the investor is obligated to sell the stock a: 60, if exercised, because he is short the call. 3 The premium of the contract is $3 per share. Options contracts are issued with 100 shares, so the total premium is $300.
36
Buyers of calls want the market price of the underlying stock to
rise.
37
Writers of calls want he market price of the underlying stock to
fall or stay the same.
38
When is a put writer bullish investor?
because he wants the market to rise or remain unchanged. The contract is not exercised if the market price is above the strike price.
39
When is a put buyer bearish investor?
because he wants the market to fall. The put is exercised only if the market price falls below the strike price
40
Describe index option
A stock index option tracks the performance of a particular group of stocks such as the S&P 500 Index or Dow Jones Industrial Average (DJLA). If an index option is exercised, no delivery of the underlying shares is made. Instead, the writer pays the options owner the differential in cash.
41
What is long put (purchase)?
A put buyer owns the right to sell 100 shares of a specific stock at the strike price before the expiration if he chooses to exercise the contract.
42
Describe Puts
An investor may buy puts (go long) or sell puts (go short).
43
What is short put(sale)?
A put writer (seller) has the obligation to buy 100 shares of a specific stock at the mike price if the buyer exercises the contract.
44
Explain Long 1 XYZ Jan 60 Put at 3. What is the total premium?
Long The investor has bought the put and has the right to exercise the contract XYZ The single contract represents 100 shares of XYZ stock. Jan The contract expires on the third Friday of January at 11:59 pm ET. 60 The strike price of the contract is 60. Put The type of option is a put, and the investor has the right to sell the stock at 60 because he is long the put. 3 The premium of the contract is $3 per share. Contracts are issued with 100 shares, so the total premium is $300. The investor paid the premium to buy the put.
45
Short The investor has sold the put and has obligations to perform if the contract is exercised. XYZ The single contract represents 100 shares of XYZ stock Jan The contract expires on the third Friday of January at 11:59 pm ET. If expiration occurs, the writer keeps the premium without any obligation. 60 The strike price of the contract is 60. Put The type of option is a put, and the investor is obligated to buy the stock at 60, if exercised, because he is short the put. 3 The premium of the contract is $3 per share. Options contracts are issued 100 shares, so the total premium is $300. summarize this
Sort 1 XYZ Jan 60 Put a 3
46
An investor is long 1 XYZ May 40 call and XYZ stock has a current market value of 44. Which of the following is true? A. The May 40 call is at the money. B. The May 40 call is in the money. C. The May40 call is out of the money. D. The May40 call has no intrinsic value.
B
47
An investor is long 1 August XYZ 30 put and XYZ is has a current market value of 25. Which of the following is true? A. The August 30 put is in the money by 5 points. B. The August 30 put is at the money. C. The August 30 put is out of the money by 30 points. D. The August 30 put has no intrinsic value.
A
48
An investor writes (sells) a July 25 ABC call. Which of the following is true? A. The investor has the right to purchase ABC stock at 25. B. The investor has the right to sell ABC stock at 25. C. The investor will be obligated to purchase ABC stock at 25 if the call is exercised by the owner (buyer). D. The investor will be obligated to sell the ABC stock at 25 if the call is exercised by the owner (buyer).
D
49
An investor writes a September 65 ABC put for $3 when the stock is trading at $63. Which of the following is true? A. The Intrinsic value is $3. B. The intrinsic value is $2 and the time value is $1. C. The intrinsic value is $1 and the time value is $2. D. The investor has the right to purchase ABC stock at 65.
B
50
Describe call in the money
A call is in the money when the price of the stock exceeds the strike price of the call. A buyer will exercise calls that are in the money at expiration. Buyers want options to be in the money, sellers do not.
51
Describe at the money for call
A call is at the money when the price of the stock equals the strike price of the call. A buyer will not exercise contracts that are at the money at expiration.
52
When is call - out of money
A call is out of the money when the price of the stock is lower than the strike price of the call. A buyer will not exercise calls that are out of the money at expiration. Sellers want contracts to be out of the money; buyers do not. Sellers then keel the premium without obligations to perform.
53
When does call have -intrinsic value
is the same as the amount a contract is in the money. A call has intrinsic value when the market price of the stock is above the strike price of the call.
54
True or False | Options have negative intrinsic value; intrinsic value is always a negative amount
False | Options never have negative intrinsic value; intrinsic value is always a positive amount or zero.
55
Options that are __________ or out of the money have an intrinsic value of zero
at the money
56
What is parity in call?
A all option is at parity when the premium equals intrinsic value.
57
An investor might make money in a strong bull market by A. selling shares short B. buying equity index puts. C. buying equity index calls. D. selling equity index calls.
C
58
A call that has no intrinsic value will
simply be allowed to expire.
59
``` If the owner of an option may only issue exercise instructions on the last day of trading, this is an example of A. a European-style option. B. an American-style option. C. an expiration-style option. D. a Eurasian-style option. ```
A
60
Your customer is a large exporter of electronic devices. They are delivering a large shipment to Japan and are concerned that the value of the Japanese yen may drop before they receive payment in order to hedge this currency risk, your customer should A. buy yen calls. B. sell yen calls. C. buy yen puts. D. sell yen puts.
C
61
What is an American-style option?
allows the owner of a contract to exercise anytime before expiration. Nearly all equity and equity index options are American style.
62
ABC stock is at 62. ABC June 60 call trading at 2.Is it trading at parity explain your answer
With ABC stock trading at 62, a 60 all has an intrinsic value of 2 (stock price 62 -strike price 60= 2). Given this call contract is trading at a premium of 2, it is known to be trading at parity.
63
What is a European-style option?
European-style options can be exercised only on expiration day. Foreign currency and yield-based options are European style.
64
Describe in the money-put
when the price of the stock is lower than the strike price of the put. A buyer will exercise puts that are in the money at expiration.
65
Describe at the money-put
when the price of the stock equals the strike price of the put. A buyer will not exercise contracts that are at the money at expiration.
66
Define intrinsic value-put
Intrinsic value is the same as the amount a contract is in the money. A put has intrinsic value when the market price of the stock is below the strike price of the put.
67
Describe out of money-put
A put is out of the money when the price of the stock is higher than the strike price of the put. A buyer will not exercise puts that are out of the money at expiration.
68
Describe parity-put
A put option is at parity when the premium equals intrinsic value.
69
What is the formula for premium?
intrinsic value plus time value = premium | IV + TV = Pr
70
What are the 2 parts of a premium?
the intrinsic value and the time value
71
Who is the primary regulators for options?
Options Clearing Corporation (OCC) and for trading options, the Chicago Board of Options Exchange (CBOE).
72
Before any trading can take place, an options account must be approved by a ________________of the firm.
Registered Options Principal (ROP)
73
What is an options disclosure document (ODD)?
explains options strategies, risks, and rewards and is designed to provide full and fair disclosure to customers before they begin options trading.
74
Explain the process for option account approval
The representative provides the customer with a copy of the options disclosure document. The account is approved for options trading by a Registered Options Principal. Option trades may be entered. Then, not later than 15 days after the account approval, the customer must return the signed options agreement. The options agreement states that the customer has read the ODD, understands the risks of options trading, and will honor all rules regulations regarding options trading. By signing, the customer also agrees to advise the firm if any changes occur in his financial situation, investment objectives, and so forth that would impact whether or not the account should still be approved for options trading.
75
What is a broad based index?
reflect movement of the entire market and include the S&P 100 (OEX), S&P 500, and the Major Market Index (XMI).
76
What is narrow based index?
track the movement of market segments in a specific industry, such as technology or pharmaceuticals.
77
What is option on indexes?
allow investors to profit from the movements of markets or market segments and hedge against these market swings.
78
What does index option typically use as multiplier?
typically use a multiplier of $100. The premium amount is multiplied by $100 to calculate the option's cost, and the strike price is multiplied by $100 to determine the total dollar value of the index.
79
What does VIX measure?
measure of the implied volatility of the S&P 500 Index options traded on the CBOE.
80
``` An investor is long 1 January 30 call at2. Calculate the breakeven, maximum gain, and maximum loss. A. BE 30, MG unlimited, ML 200 B. BE 32, MG 200, ML unlimited C. BE 32, MG unlimited, ML 200 D. BE 2. MG 500, ML 32 ```
C
81
``` An investor is long 1 January 15 put at 4. Calculate the breakeven, maximum gain, and maximum loss. A. BE 11, MG 1100, ML 400 B. BE 19, MG unlimited, ML 400 C. BE 11 MG 400, ML unlimited D. BE 19, MG 1100. ML 400 ```
A
82
All of the following are true except A. breakeven (BE) is always the same number for both buyer and seller of an option contract B. the maximum loss for options buyers is the premium paid. C. the maximum gain for options buyers is always unlimited. D. BE is calculated using the same formula for both buyer and seller.
C
83
``` Which of the following positions/actions would cover a client who has 1,000 shares of the Seabird Coffee Company (Ticker BCC)? A. A long stock position B. Buying 10 BCC puts C. Buying 10 BCC calls D. A short stock position ```
B
84
``` Mr. Perez dislikes Seabird Airlines because of a bad experience on a flight to Portland. He thinks the company's stock is overvalued. He is currently short 1,000 shares of the company. He is concerned with the potentially unlimited risk he is exposed to and would like to use options to hedge that risk. His best option position would be A. buy 10 Seabird Airline calls. B. buy 10 OD( (S&P 100 index) calls. C. sell 10 Seabird Coffee calls. D. buy 10 Seabird Coffee puts. ```
A
85
Ms. Johansen purchased 100 shares of Natasha Publishing two years ago for $40 a share. The dock has risen to $62 a share. She is concerned that the recent death of the founder and CO may negatively impact the stock. Asa hedge the buys a 60 put on the stock for $2. Her breakeven price on this position is A. $64/share. B. $62/share. C. $58/share. D. $42/share.
D
86
What is a covered call option contract?
the writer already owns the underlying security. This ensures the writer's ability to perform (deliver), should the owner exercise the contract.
87
When is a call option contract considered naked?
If the contract is uncovered (naked), the writer does not own the underlying security. If the contract is exercised by the owner, the writer will need
88
Explain covered put option
If the contract is covered, the writer already has sufficient cash available to buy the stock This ensures the writer's ability to perform (purchase), should the owner exercise the contract.
89
Describe Covered against a short stock for put
You may see a reference to a covered put where the customer is short the stock and writes the put. if the option is exercised, the customer buys the stock from the option's owner and then delivers the stock to cover the short.
90
Short 1 XYZ July 30 put If the owner exercises the call, the writer will be required to buy the stock at the strike price (30). If the stock falls in value to SO. the put writer would be forced to buy worthless securities for 53,000. The loss would be 53.000 (the cost of the worthless stock) minus the initial premium collected. This is substantial, but not unlimited, as it would be in the naked call writer's case. This explains what put option
Uncovered put (naked)
91
What is protective put
An investor who is long stock (bullish) could buy a put option as a hedge against the stock falling in value. The put would ensure that the client could sell the stock at no less than the option's strike price if the share price declines.
92
What is the formula for Breakeven for protective put
breakeven = stock price + premium
93
What are the steps to creating an account to trade options | ?
A representative must believe that options arc a suitable investment for a client based on the client's circumstances and objectives. The representative provides the customer with a copy of the options disclosure document. The account is approved for options trading by a Registered Options Principal. Option trades may be entered. Then, not later than 15 days after the account approval, the customer must return the signed options agreement.
94
The _________ states that the customer has read the ODD, understands the risks of options trading, and will honor all rules regulations regarding options trading.
options agreement
95
Mr. Darcy owns 5,000 shares of English Manor Properties. It is his belief that the company is unlikely to grow much over the next year. He is curious how he might generate some additional income from the position because English Manor pays a paltry dividend and asks about covered calls. You tell him that A. writing calls against his stock position is a conservative strategy for generating income. B. writing calls against his stock position is a conservative strategy but is ineffective for generating income. C. selling covered calls is very aggressive but has a solid chance of generating substantial income. D. buy puts is the best hedge against this position.
A
96
If a customer had a large cash position and was interested in purchasing stock at prices below where they are today, and possibly generating some income in the process, an option strategy would be to A. write covered puts that are currently out of the money. B. write uncovered calls that are currently out of the money. C. buy out-of-the-money calls. D. place a buy stop order below the market.
A
97
``` Which of the following positions has unlimited risk? A. Short 5 BCC puts B. Long 500 BCC and short 5 BCC calls C. Short 500 BCC and short 5 BCC puts D. Short 500 BCC and long 5 BCC calls ```
C
98
When is a put considered naked?
If the contract is uncovered (naked), the writer does not have the cash on hand to purchase the stock at the strike price. If the contract is exercised by the owner, the writer will need to come up with the cash from somewhere.
99
£3000 in the account Short 1 XYZ July 30 put If the owner (not our customer) exercises the put, the writer (our customer) wilt be required to buy the stock at the strike price (30) at a cost of 53.000. They are then the owners of 100 shares of XYZ stock. This explains
Covered put
100
What is protective call?
An investor who is short stock (bearish) could buy a call option as a hedge. "the call would ensure that the client could buy the stock back at no more than the option's strike price if the shares rise in value.
101
______________ contracts entail much more risk due to the uncertainty in price regarding purchase of the security in the current marketplace if the contract is exercised.
Uncovered (naked)
102
How can a customer breakeven in protective put?
the value of the stock the customer owns must rise above what he paid for the stock by enough to cover the cost of the option position.
103
What is the formula for Breakeven for protective call
breakeven = stock price — premium
104
How can a customer breakeven in protective call?
the value of the stock the customer shorted must fall below what she paid for the stock by enough to cover the cost of the option position.
105
When calculating the breakeven of a protective put, you must remember that there are two pans to the position—a
long stock and a long put.
106
What is a put writer's MG ?
is the premium received. The MG is earned when the stock price is at or above the exercise price at expiration.
107
What is a put writer's ML
is the put's strike price less the premium received (the same as the BE); it occurs when the stock price drops to zero. The investor is forced to buy the worthless stock at the option's strike price. The investor's loss is reduced by the premium received.
108
A short stock position has _________.
unlimited risk
109
What is a short put?
Remember that put sellers (writers) are bullish. By writing puts, an investor can profit if the stock price rises.
110
When calculating the breakeven of a protective call, you must remember that there are two pans to the position—a
short stock and a long call.
111
What is a puts BE?
Once again, for puts, the BE is found by subtracting the premium from the strike price. For the put seller, the contract is profitable at or above the BE at expiration.
112
True or False | The breakeven calculations shown are for an option, and not for a combined position like a stock plus an option.
The breakeven calculations shown are for an option, and not for a combined position like a stock plus an option. If a question has a customer position that has both an option and a stock in it, the formulas above do not apply. The correct formula for those position will be covered later.
113
Short 1 July 40 put at 3 | What is ML
ML= from the BE down too; the same as BE = 37 points ($3,700)
114
What is long call?
By purchasing calls, an investor can profit from an increase in a stock's price.
115
What is short call?
Remember that all sellers (writers) are bearish. By writing calls, an investor can profit if the stock price falls.
116
How is BE found for calls?
For calls, the BE is found by adding the strike price and the premium. For the all buyer, the contract is profitable above the BE.
117
Short 1 July 40 put at 3 | What is the BE
BE= strike price - premium (40 - 3) =37
118
What is MG calls?
the potential gains available to all buyers are unlimited because there is no limit on how far a stock's price can rise. In theory, it can rise to infinity; thus, the potential gain is unlimited.
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Long 1 July40 call at 3 | What is the BE for call
BE= strike price + premium (40+3)=43
120
Short 1 July 40 put at 3 | Is the put buyer profitable
At or above 37, the put writer is profitable.
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Long 1 July40 call at 3 | Is the call buyer profitable
Above 43, the all buyer is profitable.
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Long 1 July40 call at 3 | What is MG call
MG= unlimited, because the stock can rise to infinity
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Short 1 July 40 put at 3 | What is the MG?
MG = premium received (3 points) = $300

Investments (securities) (15 decks)

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