978-0134083308 Chapter 14 Part 3

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27) Which of the following variables are part of the Black-Scholes option pricing model?

I. the market price of the underlying stock

II. the volatility of the underlying security

III. the strike price of the option

IV. the risk-free rate of interest

V. the beta of the underlying security

VI. the time remaining before the option expires

A) I, II, IV and VI only

B) I, II and III only

C) I, II, III, IV and VI only

D) I, II, III, IV, V and VI

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28) Which one of the following options is more expensive? Show all calculations.

(a) A six-month put that carries a $40 strike price on a stock that is currently trading at $35.84,

given that the put trades at a 15 percent investment premium; or

(b) A six-month call that carries a $50 strike price on a stock that currently trades at $54.75,

while the call trades with a 12 percent investment premium.

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14.4 Learning Goal 4

1) Options can provide a lot of price action for a limited dollar investment.

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2) One of the primary advantages of options is the leverage they provide.

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3) The maximum amount the buyer of a put can lose is the cost of the option.

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4) The writer of a call option is theoretically exposed to an unlimited loss.

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5) The prices of puts and calls on the same stock move independently of one another.

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6) Once the call premium is recouped, the profit from a call is only limited by the price

increases of the underlying stock prior to the contract expiration.

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7) If a stock price does not rise or fall by the amount of the option premium, the option will not

be exercised.

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8) The longer the time to expiration, the lower the option time premium tends to be.

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9) The maximum loss that can be incurred as the buyer of an option is the amount of the option

premium.

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10) Paul writes a put with a strike price of $35. The most he could lose by writing the put is

$3,500.

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11) A naked option is a conservative investment with limited risk.

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12) An option straddle is the simultaneous purchase (or sale) of both a put and a call option on

the same underlying security.

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13) Kyle believes the price of Ajax stock is about to decrease. If he wants to profit from the

decline in price, he should ________ on Ajax stock.

A) buy a call

B) write a put

C) buy a put

D) sell a put

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14) Roselle paid $250 to buy one put option with a strike price of $35. What is the maximum

profit Roselle can earn on her option contract?

A) $100

B) $350

C) $3,250

D) Her profit potential is unlimited.

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15) The price of ABC stock is currently $42 per share, but in six months you expect it to rise to

$50. ABC does not pay a dividend. You buy a six-month call on ABC, with a strike price of

$45. The option cost $200. What holding period return do you expect on this call? Ignore

transaction costs and taxes.

A) 150%

B) 200%

C) 250%

D) 300%

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16) Tiffany would like to own shares of Blackwood, Inc. but only if she can acquire them at a

total cost of $30 a share or less. Blackwood is currently trading at $31.76. Cynthia should

________ with a strike price of $30. Ignore transaction costs.

A) buy a call

B) buy a put

C) write a call

D) write a put

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17) Fred bought 600 shares of Edgewood stock at a price of $19. The stock is currently selling

for $53 a share. To protect his profits, Fred should buy

A) 600 call options with a strike price of $55.

B) 600 put options with a strike price of $50.

C) 6 call options with a strike price of $55.

D) 6 put options with a strike price of $50.

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18) Shares of Lakewood, Inc. are currently selling for $52.63. You believe the stock will

decline in price ranging from $30 to $32 in the next few months. Which of the following

strategies will allow you to profit if your prediction is correct?

I. short the stock

II. buy a call at 50

III. write a call at 55

IV. buy a put at 45

A) II and IV only

B) I and III only

C) III and IV only

D) I, III and IV only

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19) In January, JB stock was selling for $50 per share. When the calls and the puts with a

strike price of $45 expired on March 20, JB was selling at $46. Which investors made a profit?

I. the writer of the call

II. the buyer of the call

III. the writer of the put

IV. the buyer of the put

A) II and III

B) I and III

C) only III

D) II and IV

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20) In nearly all cases, the purpose of a hedge is to

A) reduce or eliminate risk.

B) make a very high profit in an extremely short time frame.

C) speculate on a downward drop in a general market index.

D) speculate on an upward movement in a given currency.

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21) Which one of the following actions would be the most appropriate hedge to a short sale of

common stock?

A) sale of a call

B) purchase of a call

C) sale of a put

D) purchase of a put

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22) Steve bought 300 shares of stock at a price of $20 per share. The price of the stock then

went up to $33 per share so Steve decided to hedge his position by purchasing 3 puts at a cost

of $120 each. The puts have an exercise price of 30. One week prior to the expiration of the

puts, the price of the stock was at $22 per share. If Steve closed out all of his positions at that

time, he would have earned a net profit of

A) $200.

B) $240.

C) $2,640.

D) $3,000.

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23) Allison bought 100 shares of MIKO, Inc. stock at a price of $35 a share. In addition, she

bought a 35 put on MIKO at a cost of $125. Which of the following are true about Allison’s

position from now until the option expiration date?

I. Her maximum loss is $3,625.

II. Her maximum loss is $125.

III. Her minimum gain is $125.

IV. Her maximum profit is unlimited.

A) I and IV only

B) II and III only

C) II and IV only

D) II, III and IV only

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24) What is the difference between a naked call option and a covered call option? Which one is

riskier and why?

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25) Alan just bought 100 shares of Global, Inc. (GLO) at $45 per share and as protection he

also bought a three-month put with a $45 strike price at a cost of $400. One of two scenarios is

expected to occur in the next three months: (a) GLO stock declines to $33; and (b) GLO stock

rises to $61. Calculate the profit or loss under each scenario and explain how the hedge has

provided protection for Alan’s position in GLO. Ignore transaction costs.

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14.5 Learning Goal 5

1) For the writer of in-the-money covered calls , losses on the options contract will be nullified

by gains on the stock.

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2) Writing covered calls may result in a profit to the writer even if the stock price does not

change.

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3) Writing covered calls protects the writer from losses if the price of the underlying stock

declines.

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4) Covered call writers have unlimited loss exposure as well as unlimited profit potential.

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5) For a spread to be successful, the difference in strike prices must be greater than the net cost

of the purchased option(s).

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6) Matt owns 500 shares of IKM stock. The market price of IKM is $51.74. Matt just sold five

calls on IKM with a strike price of $50. This is known as

A) writing a naked call.

B) writing a covered call.

C) creating a naked cover.

D) covering a short position.

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