978-0134083308 Chapter 14 Part 4

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7) Justin owns 400 shares of ORNG stock which he bought 10 months ago at $20 per share and

has now risen to $35 per share. He is afraid the stock price will fall before he has owned it for

a full year, but wants to postpone realizing profits on the stock for several months, when it will

become a long-term rather than short-term gain. He can protect his profit and avoid the short-

term capital gains rate by

A) writing covered calls.

B) writing puts.

C) buying puts.

D) buying calls.

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8) Bill owns 200 shares of EG stock. In November, the market price of EG was $15.45. Bill

sold two March 16 calls on EG for $246. Between November and March, EG stock fluctuated

between $14.75 and $15.85. EG paid a quarterly dividend of $0.40 per share on January 31.

Over the November-March period, Bill earned

A) $80.

B) $(176).

C) $326.

D) $256.

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9) Mary wrote a 40 call on ABC stock at a price of $275. She does not own any shares of ABC.

Mary has

I. limited her losses to $275.

II. unlimited loss potential.

III. limited her gains to $275.

IV. unlimited profit potential.

A) I and IV only

B) II and III only

C) I and III only

D) II and IV only

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10) The writer of a covered call has taken a(n)

A) conservative investment position with unlimited potential profits.

B) conservative investment position with limited profits.

C) aggressive position with limited losses and unlimited potential profits.

D) aggressive position with potentially unlimited profits or losses.

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11) A vertical spread with limited risk might involve

A) buying a call and a put on the same stock with the same strike price.

B) buying a put at a lower strike price and a call at a higher strike price.

C) buying a call at a lower strike price and writing a put at a higher price.

D) buying a call at a lower strike price and writing a call at a higher strike price.

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12) The purchase of a June 25 call on XXO stock and the sale of a June 30 call on XXO stock

is known as a

A) long straddle.

B) short straddle.

C) vertical spread.

D) horizontal spread.

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13) Mathew simultaneously sold a July 40 put on ZXY stock for $200 and bought a July 35 put

for $75. His maximum loss is ________ and his maximum gain is ________.

A) $375; $125

B) $375; unlimited

C) $500; $125

D) $275; $125

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14) A long straddle

A) consists of selling and writing an equal number of puts and calls with different strike prices

but the same expiration date and the same underlying security.

B) is a strategy based on the expectation that the price of the underlying security will be

relatively constant.

C) consists of buying a call at one strike price and then writing a call at a higher strike price.

D) is a strategy that produces profits when the price of the underlying security moves

significantly in either direction.

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15) Amy owns 100 shares of ABC stock with a cost basis of $35 a share. The stock is currently

trading at $54 a share. Amy believes the price of ABC stock will fall to $45 a share in the near

future but over the longer term of 3 to 5 years, increase in value to $75 a share. Amy would like

to benefit from the expected near-term decline if it occurs. Therefore, Amy writes a covered

call at a strike price of $55 and a premium of $2.

(a) How will the covered call help Amy profit if the expected price decline occurs?

(b) What is the maximum loss Amy can incur from the call?

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14.6 Learning Goal 6

1) While stock index options can be used to play the market as a whole, they are also effective

in protecting equity portfolios against falling markets.

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2) To exercise a call option on the Dow Jones Industrial Average, an investor would need to

actually buy all 30 stocks at the strike price.

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3) The value of an interest rate call option increases when interest rates fall.

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4) The Dow-Jones Industrial Average is at 17,800. A call option on the Index with a strike

price of 177 would be in the money.

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5) Long-term Equity AnticiPation Securities (LEAPS) are a form of option that gives the holder

the right to buy newly issued shares of stock directly from the issuing corporation.

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6) If the S&P 500 index is at 2,082, then the cash value of an S&P 500 index option is

A) $20.82.

B) $2,082.

C) $20,820

D) $208,200.

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7) One could temporarily protect profits on a highly diversified portfolio of large company

stocks by

I. selling S&P 500 Index put options.

II. buying S&P 500 Index put options.

III. buying S&P 500 Index call options.

IV. selling S&P 500 Index call options.

A) I and III only

B) I, II and III only

C) II and IV only

D) I, II and IV only

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8) Bob’s DJIA Index call option had a strike price of 181. When he exercised the option, the

Dow was at 18,350.

A) Bob received $2,500 from the writer of the contract.

B) Bob paid $250 to the writer of the contract.

C) Bob received $250 from the writer of the contract.

D) Bob paid $2,500 to the writer of the contract.

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9) The premium on a stock index call would be expected to increase as the

A) market becomes more volatile.

B) option life nears expiration.

C) index price falls further below the strike price.

D) underlying securities stabilize in value.

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10) ETF options are settled in

A) cash.

B) ETF shares.

C) share of the companies in the index.

D) The writer has the choice of settling in either cash or ETF shares.

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11) Anthony is confident that shares of SolarTech will greatly increase in value, but thinks that

it may be a year or more before that happens. He should buy

A) ETF calls.

B) LEAP puts.

C) LEAP calls.

D) Index calls.

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12) Stock index options can be used for which of the following investment purposes?

I. protect a portfolio from market declines

II. speculate on the price appreciation of a particular common stock

III. take advantage of a leverage opportunity

IV. create a portfolio hedge

A) I and IV only

B) II and IV only

C) I and III only

D) I, III and IV only

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13) The value of an interest rate call option

A) varies directly with the price of the underlying corporate bond.

B) increases when the yield on the underlying Treasury security rises.

C) is based on the market price of U. S. Treasury securities.

D) decreases when the price of U.S. Treasuries decreases.

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14) If the Canadian dollar became stronger relative to the U.S. dollar, the price of

A) a call option on the Canadian dollar will increase.

B) a put option on the Canadian dollar will increase.

C) a call option on the Canadian dollar will decrease.

D) both the call and the put options on the Canadian dollar will decrease.

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15) If yields on Treasury bonds rise

A) the value of the corresponding bonds will rise and the value of interest rate index options

will fall.

B) the value of the corresponding bonds and the value of interest rate index options will both

fall.

C) the value of the corresponding bonds will fall and the value of interest rate index options

will rise.

D) the value of the corresponding bonds and the value of interest rate index options will both

rise.

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16) Which of the following statements concerning Long-term Equity AnticiPation Securities

(LEAPS) is correct?

A) LEAPS are traded solely in the over-the-counter market.

B) LEAPS are options that are available only on individual common stocks.

C) LEAPS typically have a higher quoted price than that of a regular option.

D) LEAPS generally have a longer life than a warrant.

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17) Which of the following methods might be used to protect a profit on a diversified portfolio

of stocks?

A) Buy S&P 500 Index put options.

B) Buy put options on a S & P 500 based ETF.

C) Write S&P 500 Index put options.

D) Either A or B, but not C.

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18) An investor who exercises a call option on a S&P 500 ETF will

A) purchase ETF shares at the strike price.

B) receive a cash settlement equivalent to the difference between the strike price and the

current level of the index.

C) receive a cash settlement equivalent to the difference between the strike price and 100 times

the current level of the index.

D) receive a cash settlement equivalent to the difference between the strike price and the

current price of the ETF.

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19) Explain how an investor can use a stock market index option to hedge a portfolio of

common stocks.

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