4) The writer of a call option is theoretically exposed to an unlimited loss.
5) If you expect the price of a security to decline, you could buy a call to protect your financial
position.
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.
7) If a stock price does not rise or fall by the amount of the option premium, the option will not
be exercised.
8) The longer the time to expiration, the lower the option time premium tends to be.
9) The maximum loss that can be incurred as the buyer of an option is the amount of the option
premium.
10) Option writing can be very profitable because the majority of options are never exercised.
11) A naked option is a conservative investment with limited risk.
12) An option straddle is the simultaneous purchase (or sale) of both a put and a call option on
the same underlying security.
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
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.
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%
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
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.
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
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
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.
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
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.
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
24) 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.
25) 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
26) 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.
27) 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.
28) 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.
29) What is the difference between a naked call option and a covered call option? Which one is
riskier and why?
30) 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.
1) For the writer of in-the-money covered calls , losses on the options contract will be nullified
by gains on the stock.
2) Writing covered calls may result in a profit to the writer even if the stock price does not
change.
3) Writing covered calls protects the writer from losses if the price of the underlying stock
declines.
4) Covered call writers have unlimited loss exposure as well as unlimited profit potential.
5) 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.
6) 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) $336.
D) $256.
7) 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
8) 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.
9) 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?
(c) What is the maximum profit Amy can incur from the call?
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.
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.
3) 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.
4) If the S&P 500 index is at 1,061, then the cash value of an S&P 500 index option is
A) $10.61.
B) $1,061.
C) $10,610.
D) $106,100.
5) One could temporarily protect profits on a highly diversified portfolio of large company
stocks by
A) selling S&P 500 Index put options.
B) buying S&P 500 Index put options.
C) buying S&P 500 Index call options.
D) selling S&P 500 Index call options.
6) Bob’s DJIA Index option had a strike price of 98. When he exercised the option, the Dow was
at 10,050.
A) Bob received $2,050 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 received $700 from the writer of the contract.
7) 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.
8) 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.
9) 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.
10) 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
11) 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.
12) 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.
13) The currency option strike price of 163 means that
A) $1 is worth 1.63 units of the foreign currency.
B) $1 is worth 163 units of the foreign currency.
C) one unit of the foreign currency is worth $1.63.
D) one unit of the foreign currency is worth $163.
14) 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.
15) Which of the following characteristics apply to warrants?
I. Warrants are similar to call LEAPS.
II. Warrants pay quarterly dividends.
III. Warrants can generate capital gains.
IV. Warrants normally cover two or less shares of the underlying security.
A) I, II and III only
B) II and IV only
C) I, III and IV only
D) III and IV only
16) Explain how an investor can use a stock market index option to hedge a portfolio of common
stocks.