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Derivatives【Reading 63】Sample

Regarding buyers and sellers of put and call options, which of the following statements concerning the resulting option position is most accurate? The buyer of a:
A)
call option is taking a long position and the buyer of a put option is taking a short position.
B)
put option is taking a short position and the seller of a call option is taking a short position.
C)
call option is taking a long position while the seller of a put is taking a short position.



The buyers of both puts and calls are taking long positions in the options contracts (but the buyer of a put is establishing a potentially short exposure to the underlying), while writers (sellers) of each are taking short positions in the options contracts.

Which of the following statements about put and call options at expiration is least accurate?
PutCall
A)
The maximum gain to the buyer is unlimited.The maximum loss to the writer is the premium.
B)
The maximum loss to a writer is their cost on the stock less the premiumThe maximum gain to the buyer is unlimited.
C)
The maximum gain to the buyer is limited to the stock price less the premium price.The maximum gain to the buyer is unlimited.



The maximum gain to the buyer of a put is limited to the value of the stock less the premium.
The maximum loss to the writer of a call is unlimited.

TOP

Which of the following represents a long position in an option?
A)
Writing a call option.
B)
Buying a put option.
C)
Writing a put option.



A long position is always the buying position. Remember that the buyer of an option is said to have gone long the position, while the writer (seller) of the option is said to have gone short the position.

TOP

Which of the following statements about options is most accurate?
A)
For call options, the lower the strike price relative to the stock's underlying price, the more the call option is worth.
B)
Most options throughout the world are European options.
C)
A put writer who deposits shares of the underlying stock has written a covered put.



The other statements are false. Most options throughout the world are American options. A call writer who deposits shares of the underlying stock has written a covered call.

TOP

A European option can be exercised by:
A)
its owner, only at the expiration of the contract.
B)
its owner, anytime during the term of the contract.
C)
either party, at contract expiration.



A European option can be exercised by its owner only at contract expiration.

TOP

Which of the following statements concerning an American-style option is least accurate?
A)
It allows the holder the right to exercise before maturity of the option.
B)
The predominant option type is American-style, rather than European-style.
C)
They are only traded in the U.S.



American-style options are traded throughout the world. The “American” label simply identifies the option as having the right to be exercised before maturity. American-style options are the predominant type of options contract traded.

TOP

What is the primary difference between an American and a European option?
A)
The American option can be exercised at anytime on or before its expiration date.
B)
American and European options are never written on the same underlying asset.
C)
The European option can only be traded on overseas markets.



American and European options are virtually identical, except exercising the European option is limited to its expiration date only. The American option can be exercised at anytime on or before its expiration date. For the exam, the key concept relating to this difference is the value of the American option must be equal or greater than the value of the corresponding European option, all else being equal.

TOP

Which of the following statements about European and American options is least accurate?
A)
European options offer more flexible trading opportunities for speculators.
B)
American options are far more common than European options.
C)
European options are easier to analyze and value than American options.



European options are less flexible for traders than American options because of the limitation on when they can be exercised, which is only on the expiration date. Traders gain more flexibility with American options that can be exercised at anytime on or before expiration.

TOP

An investor would exercise a put option when the:
A)
price of the stock is equal to the strike price.
B)
price of the stock is above the strike price.
C)
price of the stock is below the strike price.



A put option gives its owner the right to sell the underlying good at a specified price (strike price) for a specified time period. When the stock's price is less than the strike price a put option has value and is said to be in-the-money.

TOP

Basil, Inc., common stock has a market value of $47.50. A put available on Basil stock has a strike price of $55.00 and is selling for an option premium of $10.00. The put is:
A)
out-of-the-money by $2.50.
B)
in-the-money by $7.50.
C)
in-the-money by $10.00.



The put allows a trader to sell Basil common stock for $7.50 more than the current market value ($55.00 − $47.50). The trade is normally closed out with a cash settlement, but the trader could buy 100 shares for $47.50 per share and immediately sell them to the option writer for $55.00.

TOP

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