Deck 17: An Introduction to Options

Question 1

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

Answer 1

True

Question 2

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

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

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

Question 7

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.

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

Arbitrage determines the maximum price of an option.

Question 13

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

Question 14

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

Question 15

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

Question 16

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

Question 17

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

Question 18

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

Question 19

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

Question 20

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

Question 21

When a call option is exercised, new stock is issued.

Question 22

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

Question 23

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

Question 24

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

Question 25

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

Question 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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

Question 31

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

Question 32

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

Question 33

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

Question 34

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

Question 35

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

Question 36

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

Question 37

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

Question 38

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

Question 39

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

Question 40

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

Question 41

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 42

Warrants are issued by

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

Question 43

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

Question 44

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 45

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

Question 46

Options to buy stock offer

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

Question 47

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 48

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 49

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

Question 50

Buying a stock index option reduces systematic risk.

Question 51

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

Question 52

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 53

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

Question 54

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 55

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 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

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

Question 58

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 59

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

Question 60

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

Question 61

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 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

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 64

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 65

One reason for writing and selling a covered call option is

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

Question 66

The CBOE is
1. a secondary market in put and call options
2. a division of the SEC that regulates 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 67

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 68

Given the following information,
      Price of a stock                  $50
      Strike price of a six-month call  $45
      Market price of the call           $9
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 ________.

f. Which call is "in" or "out" of the money?

After six months (i.e., at the expiration date of the call), the price of the stock is $52.

g. The profit (loss)from buying the call is ________.

h. The price (loss)from selling the call naked is _______.

i. The profit (loss)from selling the call covered is     __________.

j. The profit (loss)from selling the stock short six months earlier is _________.

k. At expiration, the time premium paid for a put or a call is _________.

Question 69

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

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

Question 71

A put is an option to

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

Question 72

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 73

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 74

Call options offer buyers

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

Question 75

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 76

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 77

What are the following call options' intrinsic values and time premiums if the price of the underlying stock is $55?
        Option strike price     Price of the call
           Call at $50                    $7.00
           Call at $55                     3.00
           Call at $60                     0.50

Question 78

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?

           Strike Price         Price of the Option
             $30                          $7.50
             $35                         $3.00

Question 79

A put and a call have the following terms:

Call: strike price             $50
             expiration date   six months
Put:  strike price             $50
             expiration date   six months

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 80

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