kim226

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?

A) $3.

B) $2.

C) $5.

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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.

kim226

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:

A) $4.50.

B) -$4.50.

C) -$5.00.

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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).

kim226

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 buyer is the strike price plus the option premium.

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

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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.

kim226

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:

A) $9.

B) $0.

C) $41.

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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).

kim226

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:

A) $10.

B) $0.

C) $105.

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The put has a value of $0 because it will not be exercised. Put value is MAX (0, X-S).

kim226

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?

Profit

Value of the Call

A) -$5 $9

B) $1 $9

C) -$5 $5

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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.

kim226

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?

Maximum Gain on Put

Value of the Put at Expiration

A) $40 $2

B) $39 $0

C) $42 $2

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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.

kim226

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

A) $24 $3

B) $27 $4

C) $24 $4

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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.

kim226

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.At a stock price of $43:

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.

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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.

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Which of the following statements about the investors is least accurate?

A) Grey's loss is unlimited.

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

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

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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.

kim226

An investor buys 5 calls on Stock XYZ with a strike price of $10 for a price of $1 per call. Three months later, Stock XYZ is trading for $15 per share. Each call entitles the owner to buy 2 shares of Stock XYZ. What is the investor’s net profit?

A) $45.

B) $20.

C) $0.

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($15 – $10) × (5 × 2) – ($1 × 5 calls). The gross payoff is (15 – 10) × 10 = $50. The net profit is $50 – price of calls ($5) = $45.