Deck 17: An Introduction to Options

Question 1

The intrinsic value of an option to buy stock (i.e., a call option) is the difference between the price of the stock and the per share exercise price of the option.

Answer 1

True

Question 2

The price of an option is generally less than the option's intrinsic value.

Answer 2

False

Question 3

Holders of calls do not receive the cash dividends
paid to the company's stockholders.

Answer 3

True

Question 4

Arbitrage determines the maximum price of an option.

Question 5

Arbitrage is the act of simultaneously buying and
selling in two markets to take advantage of price differentials.

Question 6

An option's intrinsic value exceeds the option's price.

Question 7

The time period to expiration for call options is usually for less than a year.

Question 8

Call options, unlike warrants, may be written by
individuals.

Question 9

A warrant is an option issued by a corporation to buy
its stock at a specified price within a specified time period.

Question 10

Investors and speculators rarely, if ever, have an opportunity to establish an arbitrage position.

Question 11

Because of arbitrage, an option should not sell for
less than its intrinsic value.

Question 12

Because of the small cash outlay to buy an option, these securities are considered to be conservative investments.

Question 13

A covered call is constructed by buying the stock and selling the call.

Question 14

Calls are options to sell stock at a specified price
within a specified time period.

Question 15

As the price of a stock rises, the time premium paid for an option to buy stock increases.

Question 16

If the price of an option to buy stock were to sell
for less than its strike price, an opportunity for arbitrage exists.

Question 17

The maximum potential profit on a covered call is the time premium paid for the stock.

Question 18

Since options offer potential leverage, they tend to
sell for a time premium.

Question 19

The time premium paid for an option reduces the option's potential leverage.

Question 20

The strike price of an option is fixed when the option is issued.

Question 21

In addition to put and call options on individual stocks, there are also options on the market as a whole (i.e., an index).

Question 22

The value of a put is inversely related to the value of
the underlying stock.

Question 23

The intrinsic value of a put is the price of the stock
minus the put's strike price.

Question 24

Calls tend to sell for a time premium that exceeds the stock's price.

Question 25

There is no limit to the potential loss from buying a call option.

Question 26

When a call option is exercised, new stock is issued.
F.23. The intrinsic value of a call option is the strike price minus the stock's price.

Question 27

The intrinsic value of a put establishes the put's
maximum price.

Question 28

Writing covered call options is more risky than writing naked call options

Question 29

Selling a covered call option is comparable to selling a stock short.

Question 30

The writer of a call option does not receive any dividends paid by the firm.

Question 31

If the price of a stock rises, the writer of a put
option profits.

Question 32

A put is an option to sell stock at a specified price
within a specified time period.

Question 33

A writer of a naked call option will lose money if the price of the stock declines.

Question 34

The profits (gains) on option trading are exempt from federal income taxation.

Question 35

The writer of a covered call cannot lose money if the price of the stock rises.

Question 36

The buyer of a call option wants the price of the stock to rise.

Question 37

The price of a call option is often more volatile than the price of the underlying stock.

Question 38

While individuals can write call options, they can only
buy put options.

Question 39

An investor may reduce risk by simultaneously purchasing a stock and a put option.

Question 40

The CBOE is a secondary market for put and call options.

Question 41

The intrinsic value of an option sets

A) the minimum price of an option
B) the maximum price of an option
C) neither an option's minimum nor its maximum price
D) both the maximum and the minimum price of an option

Question 42

The time premium paid for an option to buy stock
Is affected by

A) the length of time to expiration
B) the firm's credit rating
C) the existence of a rights offering
D) the firm's financial statements

Question 43

Stock index options permit investors to establish a
position in the market without having to select individual stocks.

Question 44

In-the-money stock index options are not exercised.

Question 45

Warrants are issued by

A) individuals
B) firms
C) governments
D) investor

Question 46

Options sell for a time premium over their intrinsic
Value because

A) they earn dividends
B) they are debt obligations
C) they offer potential leverage
D) they are long-term investments

Question 47

The intrinsic value of an option to buy stock is

A) its price
B) its strike price
C) the difference between the stock's price and the option's strike price
D) the difference between the option's strike price and the option's price

Question 48

The intrinsic value of an option to buy stock rises as

A) the strike price increases and the price of the stock declines
B) the strike price increases and the price of the stock rises
C) the strike price decreases and the price of the stock declines
D) the strike price decreases and the price of the stock rises

Question 49

The most the investor who sells a naked stock index
option can lose is the cost of the option.

Question 50

Warrants and calls do not have

A) an expiration date
B) a specified exercise price
C) the right to receive dividends
D) a strike price

Question 51

A portfolio manager with a position in many stocks may hedge the portfolio by purchasing a stock index call option.

Question 52

Buying a stock index option reduces systematic risk.

Question 53

If an investor anticipates that interest rates will increase, that individual should sell an option to buy Treasury bonds

Question 54

The most the individual who buys a put option can lose
is the cost of the option.

Question 55

Options to buy stock offer

A) potential leverage
B) potential income
C) safety of principal
D) liquidity

Question 56

If an investor constructs a covered call,

A) there is no limit to the potential profit
B) risk is increased
C) risk is reduced
D) the term of the position is increased

Question 57

A call is an option to

A) sell stock at a specified price
B) buy stock at a specified price
C) deliver stock at a specified price
D) deliver bonds at a specified price

Question 58

Because of arbitrage, the price of an option

A) exceeds its intrinsic value
B) is less than its intrinsic value
C) cannot be less than its intrinsic value
D) cannot be greater than its intrinsic value

Question 59

If an investor is bearish, he or she should not buy
a stock index call option.

Question 60

If the investor buys a stock index put, the individual
will profit if the market rises.

Question 61

What are the intrinsic values and time premiums of the following call options if the price of the underlying stock is $35? What are the profits and losses to the buyers and the writers if the stock sells for $31 at the options' expiration?

Question 62

The writer of a naked call option wants

A) the prices of the stock and the call to rise
B) the prices of the stock and the call to fall
C) the prices of the stock to fall and the call to rise
D) the prices of the stock to rise and the call to remain stable

Question 63

Which of the following is premised on lower stock prices?

A) buying a stock index call
B) buying a stock index put
C) buying a stock and selling a call
D) buying a stock and selling a put

Question 64

A put is an option to

A) buy stock
B) receive stock
C) sell stock
D) receive dividends

Question 65

The price of a call depends on
1) the strike price
2) the price of the underlying stock
3) the term (i.e., life) of the call

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 66

The value of a put rises as the price of

A) stock rises
B) a call falls
C) stock falls
D) a call rises

Question 67

A warrant is the option to buy one share of stock at $40. It expires after one year and currently sells for $10. The price of the stock is $32. What is the maximum possible profit if an investor buys one share of stock and shorts one warrant? What is the range of stock prices that yields a profit on this position?

Question 68

A writer of a call option closes the position by

A) purchasing the stock
B) selling the stock
C) purchasing the option
D) selling the option

Question 69

The CBOE is
1) a secondary market in put and call options
2) a division of the SEC that regulated option trading
3) the first organized options exchange

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 70

Which of the following assumes higher stock prices?
1) buying a stock index call
2) buying a stock index put
3) selling a stock index call
4) selling a stock index put

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4
PROBLEMS

Question 71

A put and a call have the following terms:

The price of the stock is currently $55. The price of the call and put are, respectively, $9 and $1. What will be the profit from buying the call or buying the put if, after six months, the price of the stock is $40, $50, or $60?

Question 72

Given the following information,

a. The intrinsic value of the call is _________.
b. The intrinsic value of the put is _________.
c. The time premium paid for the call is _________.
d. The time premium paid for the put is _________.
At the expiration of the options (i.e., after six months have lapsed), the price of the stock is $45.
e. The profit (loss) from buying the call is _______.

Question 73

What are the following call options' intrinsic values and time premiums if the price of the underlying stock is $55?

Question 74

If the price of a stock rises substantially, the investor who wrote a covered call
1) earns a modest profit
2) sustains a modest loss
3) lost an opportunity for a large profit

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) only 3

Question 75

Given the following information,
finish the following sentences:

a. The intrinsic value of the call is _________.
b. The time premium paid for the call is ________.
c. If an investor established a covered call position, the amount invested is _________.
d. The most the buyer of the call can lose is ________.
e. The maximum amount the seller of the call naked can lose is ________.

Question 76

Stock index options
1) permit the investor to short the market instead
Of individual stocks
2) require delivery of an index of stocks
3) limit the buyer's potential loss to the cost of
The option

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 77

Call options offer buyers

A) potential leverage
B) liquidity
C) income
D) safety of principal

Question 78

One reason for writing and selling a covered call
Option is

A) potential leverage
B) safety of principal
C) income received
D) liquidity

Question 79

The intrinsic value of a put depends on
1) the strike price
2) the price of the stock
3) the term on the put

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 80

A call option is similar to a warrant except

A) the strike price is fixed
B) it may be issued by individual investors
C) it is not marketable (saleable)
D) it receives dividend payments