Question 1

Which one of the following is a bull call spread?

Accepted Answer

A bull call spread involves buying a call at a lower strike price and selling a call at a higher strike price on the same stock, with both options expiring at the same time. This limits the potential profit but also limits the potential loss. Option A fits this description, as it involves buying a $30 call and selling a $35 call on the same stock.

Question 2

Which one of the following is a bear call spread?

Accepted Answer

The answer of Which one of the following is a...

Question 3

Which one of the following is the lower price bound for the intrinsic value of an American call option on a stock?

Accepted Answer

The lower price bound for the intrinsic value of an American call option on a stock is given by Max(S − K, 0), where S is the stock price and K is the strike price. This represents the option's value if exercised immediately, which cannot be negative; hence, the option is worth at least the difference between the stock price and the strike price, if that difference is positive.

Question 4

You bought a call option with a strike price of $40. What is your total payoff on this option contract if the underlying stock is selling for $42.70 on the option expiration date?

Accepted Answer

The total payoff from a call option is calculated by subtracting the strike price from the stock's price at expiration, if the stock's price is above the strike price. Here, the stock's price at expiration is $42.70 and the strike price is $40. Therefore, the payoff is $42.70 - $40 = $2.70. However, since options typically represent 100 shares, the total payoff is $2.70 * 100 = $270.

Question 5

Which one of the following applies to a naked call?

Accepted Answer

A naked call involves selling a call option without owning the underlying asset. This means that if the price of the underlying asset rises significantly, the seller of this call option will be required to deliver the asset to the buyer at the specified exercise price. As there is no limit to how high the price of the asset may rise, the seller faces unlimited potential losses if they are not able to purchase the stock at a lower price to fulfill their obligation.

Question 6

What is the total amount you will receive if you sell 10 June $27.50 puts on Texas Instruments?
$\text { Iexas Instruments (TXN) }$
$\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $$\text {CALL}$ $\quad $ $\quad $ $\quad $$\text {PUT}$
$\begin{array}{llllll}
\text { Exp } & \text { Strike } & \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask }\
\text { May } & 25.00 & 6.60 & 6.70 & \text { N/A } & .01 \
\text { Jun } & 25.00 & 6.50 & 6.75 & \text { N/A } & .03 \
\text { Oct } & 25.00 & 6.95 & 7.25 & .39 & .42 \
\text { May } & 27.50 & 4.10 & 4.15 & \text { N/A } & .01\
\text { Jun}&27.50&4.05&4.30&.07&.10
\end{array}$

Accepted Answer

To calculate the total amount received from selling 10 June $27.50 puts on Texas Instruments, you look at the bid price for the puts, which is $0.07. Since each option contract represents 100 shares, selling one put option would yield $7 (0.07 x 100). Therefore, selling 10 puts would yield $70 (10 x $7).

Question 7

Amy bought a $50 May call and a $50 May put on the same underlying stock. This strategy is referred to as which one of the following?

Accepted Answer

Amy's strategy is a long straddle, which involves buying a call and a put with the same strike price and expiration date. This strategy profits from significant moves in either direction, as the long call option will increase in value if the stock price goes up and the long put option will increase in value if the stock price goes down.

Question 8

Which one of the following represents an arbitrage opportunity?

Accepted Answer

The PCP-implied put price of $.30 and put market price of $.31 indicates a mispricing in the market. The actual market price is higher than the price suggested by the put-call parity formula. This can be exploited by selling the overpriced put option and buying the corresponding call option and stock, thereby locking in a risk-free profit. This is an arbitrage opportunity.

Question 9

You wrote a covered call with a strike price of $35 and an option premium of $1.10. Assume the stock price is $34 a share currently and that it falls to $32 a share and remains at that price until the option expires. As a result, you will:

Accepted Answer

Since the stock price fell to $32 and stayed below the strike price of $35 until expiration, the option would not be exercised by the buyer. Therefore, you would keep your stock and also retain the option premium of $1.10.

Question 10

A short straddle:

Accepted Answer

A short straddle involves simultaneously selling a call and a put option with the same strike price and expiration date. Its maximum profit is obtained when the underlying stock price is equal to the strike price, making it a neutral strategy. Therefore, the correct choice is C.

Question 11

How much will it cost to purchase 4 June $27.50 calls on Texas Instruments?
$\text { Iexas Instruments (TXN) }$
$\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $$\text {CALL}$ $\quad $ $\quad $ $\quad $$\text {PUT}$
$\begin{array}{llllll}
\text { Exp } & \text { Strike } & \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask }\
\text { May } & 25.00 & 6.60 & 6.70 & \text { N/A } & .01 \
\text { Jun } & 25.00 & 6.50 & 6.75 & \text { N/A } & .03 \
\text { Oct } & 25.00 & 6.95 & 7.25 & .39 & .42 \
\text { May } & 27.50 & 4.10 & 4.15 & \text { N/A } & .01\
\text { Jun}&27.50&4.05&4.30&.07&.10
\end{array}$

Accepted Answer

The answer of How much will it cost to purchase...

Question 12

You own 200 shares of Allen Bros. stock. Which one of the following would allow you to receive an option premium in exchange for selling your shares in Allen Bros. at the strike price?

Accepted Answer

Writing a covered call involves selling a call option on shares that you already own. In this case, you own 200 shares of Allen Bros. stock and can sell a covered call option on those shares, which allows you to receive an option premium in exchange for giving someone else the option to buy your shares at the strike price.

Question 13

The maximum:

Accepted Answer

The maximum profit from writing (selling) a put option is the premium received for selling the option. This is because if the stock price stays above the strike price, the option will not be exercised, and the writer gets to keep the premium.

Question 14

Katie purchased 6 call options on Atlas Co. stock with a strike price of $40. On the expiration date, the stock was priced at $38.95 a share. What is the total payoff on the option contracts?

Accepted Answer

Since the stock price at expiration ($38.95) is below the strike price ($40), the call options are out of the money and will not be exercised. Therefore, the total payoff is $0.

Question 15

Which one of the following is the primary purpose of a protective put?

Accepted Answer

The primary purpose of a protective put is to offset the risk associated with a decrease in the value of the underlying asset. It is a hedging strategy used by investors to protect their long positions in securities by purchasing put options. This allows them to sell the underlying asset at a predetermined strike price, which limits their potential losses in case the asset's value decreases. A protective put does not aim to generate profits from an expected future increase in the stock's value or provide higher returns than owning the underlying security. Option premiums are received by the seller of the option, not the buyer. A protective put may increase the potential rate of return, but only because it allows investors to take more risks in their investment strategies without exposing themselves to downside risk.

Question 16

Which one of the following is the lower price bound for the intrinsic value of an American put option on a stock?

Accepted Answer

The intrinsic value of an American put option is the value if it were exercised today. For a put option, this is the maximum of the strike price minus the stock price (K − S) and 0, because the option gives the right to sell at the strike price. If the stock price is above the strike price, the intrinsic value is 0, as exercising the option would not be beneficial. If the stock price is below the strike price, the intrinsic value is K − S, representing the profit from exercising the option.

Question 17

What is the total option premium you will receive if you sell 4 May $27.50 calls on Texas Instruments?
$\text { Iexas Instruments (TXN) }$
$\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $ $\quad $$\text {CALL}$ $\quad $ $\quad $ $\quad $$\text {PUT}$
$\begin{array}{llllll}
\text { Exp } & \text { Strike } & \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask }\
\text { May } & 25.00 & 6.60 & 6.70 & \text { N/A } & .01 \
\text { Jun } & 25.00 & 6.50 & 6.75 & \text { N/A } & .03 \
\text { Oct } & 25.00 & 6.95 & 7.25 & .39 & .42 \
\text { May } & 27.50 & 4.10 & 4.15 & \text { N/A } & .01\
\text { Jun}&27.50&4.05&4.30&.07&.10
\end{array}$

Accepted Answer

To determine the total option premium, we need to first look up the price of the May $27.50 calls on Texas Instruments. Let's assume the price is $4.10 per option.

The total option premium is calculated as follows:

Premium per option x Number of options = Total premium

$4.10 x 4 = $16.40 per contract

$16.40 per contract x 100 shares per contract = $1,640 in total option premium

Therefore, the best choice is C, as it correctly calculates the total option premium for selling 4 May $27.50 calls on Texas Instruments.

Question 18

Which one of the following values is discounted in the put-call parity formula?

Accepted Answer

The strike price is discounted in the put-call parity formula. The formula is: 
Call Price - Put Price = Stock Price - Strike Price / (1 + Risk-Free Rate) ^ Time to Expiration

Question 19

Which one of the following correctly defines the range of time values for an American put option?

Accepted Answer

An American put option gives the holder the right to sell an asset at a specified price before or on the expiration date. The value of this option can never be less than $0, as the worst-case scenario is that the option is not exercised, leading to a value of $0. It cannot have a negative value because the holder would simply choose not to exercise the option, avoiding any loss beyond the premium paid for it.

Question 20

Josh owns 2 call options on Foster Glass stock. The exercise price is $47.50 and the stock price at expiration is $49.01. What is the total payoff on the option contracts?

Accepted Answer

The payoff for one call option is the stock price at expiration minus the exercise price, which is $49.01 - $47.50 = $1.51. Since Josh owns 2 call options, the total payoff is 2 * $1.51 * 100 (since each option contract typically covers 100 shares), which equals $302.00.

Quiz 15: Stock Options