Question 1

You sold a call option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.You originally sold the call option for $3.What is the largest payout possible total payout to you for this call option?

Accepted Answer

The largest total payout you can receive from selling a call option is the premium you collected when you sold the option, which in this case is $3.

Question 2

Which of the following will increase in price as the value of the underlying asset decreases in price,from the option holder's perspective?

Accepted Answer

A put option gives the holder the right, but not the obligation, to sell the underlying asset at a predetermined price (strike price) at any time before expiration. As the value of the underlying asset decreases, the value of the put option increases, as it becomes more valuable to sell the asset at the higher strike price. Therefore, the price of a put option will increase as the value of the underlying asset decreases.

Question 3

You own 100 shares of a stock with a current price of $50 and you also own a put option of 100 shares of the stock with a strike price of $45.What is the minimum value of your portfolio at expiration? Ignore the original cost of the put option for your calculation.

Accepted Answer

At expiration, if the stock price is above $45, the put option will expire worthless and the value of the portfolio will be 100 shares x $50 = $5000. If the stock price is below $45, you can exercise the put option to sell 100 shares at $45, resulting in a portfolio value of 100 shares x $45 + the value of the put option, which would be at least $0. Therefore, the minimum value of the portfolio at expiration is $4500, which corresponds to answer choice B.

Question 4

You own a call option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.What is the largest payout possible for this call option? Ignore the original cost of the option for the payout calculation.

Accepted Answer

There is an unlimited possible payout on this option because as the stock price continues to increase, the value of the call option will continue to increase as well. The option holder can exercise the option at the $30 strike price, and sell the shares at the higher market price, resulting in unlimited potential profit.

Question 5

One of the main reasons for the name "derivatives" is that

Accepted Answer

The name "derivatives" comes from the fact that the value of these instruments derives from the value of other underlying instruments, such as stocks, bonds, or commodities. Derivatives allow investors to speculate on the future price movements of these underlying assets without having to own them outright.

Question 6

If a company is wanting to lessen the cost of a new security by imbedding a valuable option in the security,then the company is most likely to issue

Accepted Answer

Convertible debt allows the investor to convert their debt into equity (usually common stock) at a later date, providing an additional valuable option to the investor. This can lower the cost of the security for the company issuing it, as it is seen as a more attractive investment opportunity. Common stock, preferred stock, and debt do not typically have this feature.

Question 7

You own a put option on a stock and the strike price of the option is $30.The option has 3 weeks until expiration and the stock is currently priced at $35 per share.What is the largest payout possible for this put option? Ignore the original cost of the option for the payout calculation.

Accepted Answer

The largest payout for a put option occurs when the stock price drops to $0. In this case, the payout would be the strike price of $30 minus the stock price of $0, resulting in a $30 payout.

Question 8

You currently own a put option on Stock X with a strike price of $25.If the current price of Stock X is $30,then what is the in-the-money amount of the option?

Accepted Answer

The answer of You currently own a put option on...

Question 9

A put option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the stock currently sells at $38 that the put on the same stock has a value of $6.85,and the value of the call is $11.87,what is the implied risk free rate?

Accepted Answer

38 + 6.85 = B + 9.87
B = 32.98
35/(1+r)= 32.98
r = .0612

Question 10

You need to immediately purchase 100 shares of Stock X and you own a call option with a strike price of $32.The current price of Stock X is $25.Your best course of action is

Accepted Answer

Exercising the call option at a strike price of $32 would mean paying more than the current market value of the stock, resulting in a loss. Purchasing a new call option with a strike price of $25 and exercising it would also result in a loss, as the option premium would need to be paid in addition to the market purchase price of the stock. Therefore, the best course of action is to purchase the stock in the market at the current price of $25.

Question 11

A put option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the risk free rate is 6%,that the stock currently sells at $38 and the call on the same stock has a value of $6.85,what is the price of the put?

Accepted Answer

B = 35/1.06 = 33.02
38 + P = 33.02 + 6.85
P = 1.87

Question 12

You find that an investor purchases a put option on shares of Company Z stock.What is the most likely reason that an investor would make such a purchase?

Accepted Answer

An investor purchasing a put option on shares of Company Z stock is essentially placing a bet that the stock price of Company Z will decrease in the future. This could be because the investor believes that Company Z is currently overvalued and due for a price correction.

Question 13

You purchase a call option and a put option on the shares of a company.The sticker price and expiration date for the options is equal.What is the best description of the combined payoff diagram for the combination of the two options?

Accepted Answer

The combined payoff diagram for a call and put option on the same underlying asset with the same expiration date will create a V-shaped diagram with the kink at the strike price of the options. At the strike price, the value of the call and put option will be equal and cancel each other out, resulting in a flat line. Above the strike price, the call option will be profitable and below the strike price, the put option will be profitable.

Question 14

If you purchase the right to sell a share of IBM stock for a set price for a fixed period of time,then you have

Accepted Answer

Purchasing a put option gives the holder the right to sell a specific amount of an underlying asset at a set price within a specified time frame.

Question 15

An option that gives the holder the right to purchase an underlying security only at the end of a fixed period for a fixed price is an

Accepted Answer

This is an example of a European call option, as it gives the holder the right to purchase the underlying security at a fixed price only at the end of a specific period. An American call option would allow the holder to exercise their right at any time before expiration, while put options give the holder the right to sell the underlying security rather than purchase it.

Question 16

You notice that the price of a one-year call option,with a $40 strike price,is $5.The current price of the underlying stock is also $40.What should the price of a one-year put option be with a strike price of $40? Assume that the interest rate on a one-year risk free bond is 10%.

Accepted Answer

S + P = B/(1+r)+ C
40 + P = 40/1.1 + 5 ======> P = 1.36

Question 17

Bavarian Brew issued convertible bonds with a par value of $1,000.The conversion ratio on the bonds is 12.33,the current market price of the bonds is $933.75 and the underlying stock currently sells at $35.25.What is the conversion price?

Accepted Answer

933.75/12.33 = 75.73

Question 18

A call option with a $35 strike price on Bavarian Sausage stock will expire in one year.If you know that the risk free rate is 6%,that the stock currently sells at $38 and the put on the same stock has a value of $3.85,what is the price of the call?

Accepted Answer

B = 35/1.06 =33.02
38 + 3.85 = 33.02 + C
C = 8.83

Question 19

Bavarian Brew issued convertible bonds with a par value of $1,000.The conversion ratio on the bonds is 12.33,the current market price of the bonds is $933.75 and the underlying stock currently sells at $45.25.What is the conversion premium?

Accepted Answer

933.75/12.33 = 75.73
(75.73-45.25)/45.25 = .6648

Question 20

You notice that you can purchase an option for $5.The price of the underlying stock is currently $42.What is the option premium for this option?

Accepted Answer

The option premium is the price of the option itself, which is already given as $5 in the question. The price of the underlying stock is not relevant to the calculation of the option premium.

Quiz 19: Options