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LOS a: Determine the value at expiration, the profit, maximum profit, maximum loss, breakeven underlying price at expiration, and general shape of the graph of the strategies of buying and selling calls and puts, and indicate the market outlook of investors using these strategies.

Which of the following statements about put options is least accurate? The most the:

A)	writer can gain is the put premium.

B)	buyer can gain is unlimited.

C)	writer can lose is the strike price less the premium.

A stock is trading at $18 per share. An investor believes that the stock will move either up or down. He buys a call option on the stock with an exercise price of $20. He also buys two put options on the same stock each with an exercise price of $25. The call option costs $2 and the put options cost $9 each. The stock falls to $17 per share at the expiration date and the investor closes his entire position. The investor’s net gain or loss is:

The total cost of the options is $2 + ($9 × 2) = $20.

>At expiration, the call is worth Max [0, 17-20] = 0. Each put is worth Max [0, 25-17] = $8. The investor made $16 on the puts but spent $20 to buy the three options, for a net loss of $4.

Linda Reynolds pays $2.45 to buy a call option with a strike price of $42. The stock price at which Reynolds earns $3.00 from her call option position is:

To earn $3.00, the stock price must be above the strike price by $3.00 plus the premium Reynolds paid to buy the option ($42.00+$3.00+$2.45).

Al Steadman receives a premium of $3.80 for shorting a put option with a strike price of $64. If the stock price at expiration is $84, Steadman’s profit or loss from the options position is:

The put option will not be exercised because it is out-of-the-money, MAX (0, X-S). Therefore, Steadman keeps the full amount of the premium, $3.80.

Jimmy Casteel pays a premium of $1.60 to buy a put option with a strike price of $145. If the stock price at expiration is $128, Casteel’s profit or loss from the options position is:

The put option will be exercised and has a value of $145-$128 = $17 [MAX (0, X-S)]. Therefore, Casteel receives $17 minus the $1.60 paid to buy the option. Therefore, the profit is $15.40 ($17 less $1.60).

Suppose the price of a share of Stock A is $100. A European call option that matures one month from now has a premium of $8, and an exercise price of $100. Ignoring commissions and the time value of money, the holder of the call option will earn a profit if the price of the share one month from now:

The breakeven point is the strike price plus the premium, or $100 + $8 = $108. Any price greater than this would result in a profit, and the only choice that exceeds this amount is $110.

A put on Stock X with a strike price of $40 is priced at $3.00 per share; while a call with a strike price of $40 is priced at $4.50. What is the maximum per share loss to the writer of the uncovered put and the maximum per share gain to the writer of the uncovered call?

The maximum loss to the uncovered put writer is the strike price less the premium, or $40.00 ? $3.00 = $37.00. The maximum gain to the uncovered call writer is the premium, or $4.50.

An investor purchases a stock for $40 a share and simultaneously sells a call option on the stock with an exercise price of $42 for a premium of $3/share. Ignoring dividends and transactions cost, what is the maximum profit that the writer of this covered call can earn if the position is held to expiration?

This is an out of the money covered call. The stock can go up $2 to the strike price and then the writer will get $3 for the premium, total $5.

An investor buys a call option that has an option premium of $5 and a strike price of $22.50. The current market price of the stock is $25.75. At expiration, the value of the stock is $23.00. The net profit/loss of the call position is closest to:

The option is in-the-money by $0.50 ($23.00 – $22.50). The investor paid $5.00 for the call option, thus the net loss is –$4.50 ($0.50 – $5.00).

Which of the following statements regarding call options is most accurate? The:

A)	call holder will exercise (at expiration) whenever the strike price exceeds the stock price.

B)	breakeven point for the seller is the strike price minus the option premium.

C)	breakeven point for the buyer is the strike price plus the option premium.

The breakeven for the buyer and the seller is the strike price plus the premium. The call holder will exercise if the market price exceeds the strike price.

Given the profit and loss diagram of two options at expiration shown below which of the following statements is most accurate?

A)	The stock price would have to increase above $45 before the seller of the call starts losing money.

B)	The maximum profit to the short put is $5.

C)	Between a stock price of $40 and $45 the long call’s profit is between $0 and $5.

This is a graph of a long call and a short call at expiration with a $5 option premium and a strike price of $40. Between a stock price of $40 and $45 the long call’s profit is between -$5 and $0. The maximum profit to the short call is $5.

Consider a call option with a strike price of $32. If the stock price at expiration is $41, the value of the call option is:

The call has a $9 ($41 ? $32) value at expiration, because the holder of the call can exercise his right to buy the stock at $32 and then sell the stock on the open market for $41. Remember, the intrinsic value of a call at expiration is MAX (0, S-X).

Mosaks, Inc., has a put option with a strike price of $105. If Mosaks stock price is $115 at expiration, the value of the put option is:

An investor bought a 15 call for $14 on a stock trading at $20. If the stock is trading at $24 at option expiration, what is the profit and the value of the call at option expiration?

The potential gains on a call purchase are unlimited. With a stock price of $24, the call at 15 is $9 in the money. By subtracting out the 14 call price a loss of $5 results.

An investor bought a 40 put on a stock trading at 43 for a premium of $1. What is the maximum gain on the put and the value of the put at expiration if the stock price is $41?

The maximum gain on a long put is the strike price minus the premium, 40 – 1 = $39. The value at expiration is zero because the put is out-of-the-money.

An investor writes a July 20 call on a stock trading at 23 for premium of $4. The breakeven price on the trade and the maximum gain on the trade are, respectively:

Breakeven Price

Maximum Gain

The breakeven price is the premium received on the call plus the strike price. For a writer of an option, the maximum gain is the premium received.

Shigeo Kishiro recently purchased an American put option and Lendon Grey recently wrote an American call option on the same underlying stock, Tackel Sports (currently trading at $40 per share). Kishiro paid $2.75 for an exercise price of $38.00 and Grey received $3.75 for a strike price of $42. Assume that there are no transaction costs to exercise.

A)	the intrinsic put value is $0 and the put is at-the-money.

B)	if Grey exercises, he will have gained a total of $4.75.

C)	the intrinsic call value is $1.

The intrinsic value of a call is given as: max [0, S ? X], where S = stock price and X = strike price. Here, max [0, 43 ? 42] = max [0, 1] = 1.

The other answers are incorrect. Grey wrote the option and thus cannot exercise. The intrinsic value of the put is correct at $0, or max [0, X ? S], but as previously noted, the put is out-of-the money at a stock price of $43. The put is at-the-money when the stock price is equal to the strike price, or $38.

A)	Grey's loss is unlimited.

B)	Grey's maximum gain and Kishiro's maximum loss sum to zero.

C)	Kishiro's gain is limited to the strike price minus the premium.

Although options are a zero-sum game, it is the counterparty exposures that nets to zero. For example, the put buyer’s maximum loss = put writer’s maximum gain = the premium. The other statements are true. Note that the reason why Grey’s loss is unlimited is that he does not currently own the stock. In other words, he has a naked position. If the stock were to rise, Grey would be forced to buy the stock in the open market to settle the exercise of the option. Because the potential for the stock to rise is unlimited, the potential loss for the naked call writer is also unlimited.

A put option has a strike price of $80, and the stock price is $75 at expiration. The expiration day value of the put option is:

A call option has a strike price of $120, and the stock price is $105 at expiration. The expiration day value of the call option is:

A call option has an expiration day value of MAX (0, S-X). Here, X is $120 and S is $105. Because the call option is out of the money at expiration, its value is zero.

A put option has a strike price of $65, and the stock price is $39 at expiration. The expiration day value of the put option is:

A call option has a strike price of $35 and the stock price is $47 at expiration. What is the expiration day value of the call option?