Chapter 14—Options Markets
1. A ____ grants the owner the right to purchase a specified financial instrument for a specified price
within a specified period of time.
a.
call option
b.
put option
c.
sale of a futures contract
d.
purchase of a futures contract
2. A ____ requires a premium above and beyond the price to be paid for the financial instrument.
a.
futures contract
b.
call option
c.
put option
d.
B and C
3. A call option is “in the money” when the
a.
market price of the underlying security exceeds the exercise price.
b.
market price of the underlying security equals the exercise price.
c.
market price of the underlying security is less than the exercise price.
d.
premium on the option is less than the exercise price.
4. A put option is “out of the money” when the
a.
market price of the security exceeds the exercise price.
b.
market price of the security equals the exercise price.
c.
market price of the security is less than the exercise price.
d.
premium on the option is less than the exercise price.
5. When the market price of the underlying security exceeds the exercise price, the
a.
call option is in the money.
b.
put option is in the money.
c.
call option is at the money.
d.
call option is out of the money.
6. When the exercise price exceeds the market price of the underlying security, the
a.
call option is in the money.
b.
put option is in the money.
c.
call option is at the money.
d.
put option is out of the money.
7. Sellers (writers) of call options can offset their position at any point in time by
a.
selling a put option on the same stock.
b.
buying identical call options.
c.
selling additional call options on the same stock.
d.
all of the above
e.
A and B
8. The ____ is the most important exchange for trading options.
a.
New York Stock Exchange (NYSE)
b.
Chicago Board of Options Exchange (CBOE)
c.
Boston Options Exchange
d.
American Stock Exchange
9. The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the
United States.
a. True
b. False
10. ____ execute transactions desired by investors and trade stock options for their own account.
a.
Floor brokers
b.
Discount brokers
c.
Market-makers
d.
none of the above
11. A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at
$49, and rises to $55 on the expiration date. The speculator will exercise the option on the expiration
date (if it is feasible to do so). What is the speculator’s profit per unit?
a.
$1
b.
$5
c.
$2
d.
−$1
e.
−$2
12. A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at
$49, and rises to $55 on the expiration date. What is the stock price at which the speculator would
break even?
a.
$50
b.
$58
c.
$52
d.
$53
e.
$49
13. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is
presently priced at $29, and rises to $32 before the expiration date. What is the maximum profit per
unit to the speculator who owned the put option assuming he or she exercises the option at the ideal
time?
a.
−$4
b.
−$3
c.
−$2
d.
$2
e.
$3
14. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is
presently priced at $29, and rises to $32 before the expiration date. What is the stock price at which the
speculator would break even?
a.
$26
b.
$34
c.
$28
d.
$29
e.
$32
15. The ____, the higher the call option premium, other things being equal.
a.
lower the existing price of the security relative to the exercise price
b.
lower the variability of the security’s market price
c.
longer the maturity of the option
d.
A and B
16. The ____, the lower the premium on a put option, other things being equal.
a.
higher the existing price of the security relative to the exercise price
b.
greater the variability of the security’s market value
c.
longer the maturity of the option
d.
A and B
17. The longer the time to maturity, the ____ the call option premium and the ____ the put option
premium.
a.
higher; lower
b.
lower; higher
c.
higher; higher
d.
lower; lower
18. The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the
put option premium.
a.
higher; lower
b.
lower; higher
c.
higher; higher
d.
lower; lower
19. The sale of a call option on a stock the seller already owns is referred to as
a.
a covered call.
b.
a naked call.
c.
call on futures.
d.
futures on options.
20. Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4
premium per share. The pension fund sells a call option on the stock it owns. If the call option is
exercised when the price of the stock is $56, what is the gain or loss per share to the pension fund
(including its gain from holding the stock as well)?
a.
$4 gain
b.
$6 loss
c.
$2 loss
d.
$1 gain
e.
$0
21. Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.
a.
increases; increases
b.
increases; decreases
c.
limits; increases
d.
limits; decreases
22. Put options are typically used to hedge
a.
when portfolio managers are mainly concerned with a permanent decline in a stock’s
value.
b.
when portfolio managers are mainly concerned with a permanent increase in a stock’s
value.
c.
when portfolio managers are mainly concerned with a temporary decline in a stock’s value.
d.
when portfolio managers are mainly concerned with a temporary increase in a stock’s
value.
23. A savings institution has long-term fixed rate mortgages supported by short-term funds. A put option
on Treasury bond futures could be used to (ignore the premium paid for the option when you answer
this question)
a.
maintain its interest rate spread if interest rates rise, and increase its spread if interest rates
fall.
b.
maintain its interest rate spread if interest rates fall, and increase its spread if interest rates
rise.
c.
maintain its interest rate spread whether interest rates rise or fall.
d.
increase its interest rate spread whether interest rates rise or fall.
24. A speculator purchases a put option on Treasury bond futures with a September delivery date with a
strike price of 85-00. The option has a premium of 2-00. Assume that the price of the futures contract
decreases to 82-00 on the expiration date and the option is exercised at that point (if it is feasible).
What is the net gain?
a.
$1,968.75
b.
$3,750.00
c.
$3,000.00
d.
−$2,000.00
e.
$1,000.00
25. Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a
premium of 14, with an exercise price of 1800. The value of an S&P 500 futures contract is 250 times
the index. If the index on the futures contract increases to 1830, what is the gain on the sale of the
futures contract?
a.
$15,000
b.
$7,500
c.
$3,300
d.
$4,000
e.
$1,500
26. Corporations involved in international business transactions can ____ to hedge future ____.
a.
sell currency call options; payables
b.
purchase currency put options; receivables
c.
purchase currency call options, receivables
d.
purchase currency put options, payables
e.
A and B
27. If a corporation hedges payables with currency call options, it will ____ if the value of the foreign
currency is ____ than the exercise price when the payables are due.
a.
exercise the option; greater
b.
exercise the option; less
c.
let the option expire; greater
d.
let the option expire; less
e.
A and D
28. Speculators purchase currency ____ on currencies they expect to ____ against the dollar.
a.
call options; weaken
b.
put options; strengthen
c.
futures; weaken
d.
put options; weaken
29. Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the
dollar.
a.
put; strengthen
b.
put; weaken
c.
call; strengthen
d.
call; weaken
e.
A and D
30. European-style stock options
a.
are long-term options (at least one year until expiration at the time they are created).
b.
can be exercised after the expiration date.
c.
can be exercised any time until the expiration date.
d.
none of the above
31. A speculator purchased a call option with an exercise price of $31 for a premium of $4. The option
was exercised a few days later when the stock price was $34. What was the return to the speculator?
a.
25 percent
b.
−25 percent
c.
−3.2 percent
d.
−2.9 percent
32. A speculator purchased a put option with an exercise price of $56 for a premium of $10. The option
was exercised a few days later when the stock price was $44. What was the return to the speculator?
a.
−20 percent
b.
120 percent
c.
−100 percent
d.
20 percent
33. The premium on an existing call option should ____ when the underlying stock price decreases.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
34. The premium on an existing put option should ____ when the underlying stock price increases.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
35. The premium on an existing put option should ____ when there is an increase in the expected
short-term volatility of the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
36. The premium on an existing call option should ____ when there is a reduction in the expected
short-term volatility of the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
37. The premium on an existing put option should ____ when there is an increase in the expected
short-term volatility of the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
38. The premium on an existing call option should ____ when there is a reduction in the expected
short-term volatility of the stock price.
a.
be negative
b.
decline
c.
increase
d.
be unaffected
e.
A and B
39. When a stock index option is exercised, the cash payment is equal to a specified dollar amount
a.
multiplied by the index level.
b.
multiplied by the exercise price.
c.
multiplied by the difference between the index level and the exercise price.
d.
multiplied by the sum of the index level and the exercise price.
40. Long-term equity anticipations (LEAPS) represent
a.
stocks that have a maturity date.
b.
stocks that are converted to bonds once the price reaches a specified level.
c.
stock options with longer terms to expiration than the more traditional stock options.
d.
stock index futures that can have a more distant settlement date than the more typical stock
options.
41. When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock
index, they ____ their exposure to stock market conditions.
a.
reduce
b.
completely eliminate
c.
have no effect on
d.
increase
42. When stock portfolio managers use dynamic asset allocation by writing call options on a stock index,
they ____ their exposure to stock market conditions.
a.
reduce
b.
completely eliminate
c.
have no effect on
d.
increase
43. Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been
established ____.
a.
available; in numerous non-U.S. countries
b.
not available; in numerous non-U.S. countries
c.
available; only in the United States
d.
not available; only in the United States
44. Which of the following is not a difference between purchasing an option and purchasing a futures
contract?
a.
The option requires that a premium be paid in addition to the price of the financial
instrument.
b.
Owners of options can choose to let the option expire on the so-called expiration date
without exercising it.
c.
The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of
options is not.
d.
All of the above are differences between purchasing an option and purchasing a futures
contract.
45. Marcie purchases a call option on interest rate futures with an exercise price of 92-10. The premium on
the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At
this time, Marcie decides to exercise the option and closes out the position by selling an identical
futures contract. Marcie’s net gain from this strategy is $____.
a.
−2,687.50
b.
2,687.50
c.
2,375.00
d.
7,437.50
e.
none of the above
46. Reese Insurance company sold a call option on interest rate futures with an exercise price of 92-10.
The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond
futures is 97-14. At this time, the option was exercised as the buyer closed out the position by selling
an identical futures contract. Reese’s net gain from selling the call option is $____.
a.
2,687.50
b.
−2,687.50
c.
2,375.00
d.
7,437.50
e.
none of the above
47. Vince, a speculator, expects interest rates to increase and purchases a put option on Treasury bond
futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the
expiration date, the price of the Treasury bond futures contract is valued at 93-22. Vince exercises the
option and closes out the position by purchasing an identical futures contract. Vince’s net gain from
this speculative strategy is $____.
a.
−406.25
b.
4,718.75
c.
−4,718.75
d.
−812.50
e.
none of the above
48. Which of the following is not an assumption underlying the Black-Scholes option-pricing model?
a.
The risk-free rate is known and constant over the life of the option.
b.
The probability distribution of stock prices is lognormal.
c.
The world is risk-neutral.
d.
The variability of a stock’s return is constant.
e.
There are no transaction costs involved in trading options.
49. Which of the following is not true with respect to market makers?
a.
They benefit from the spread.
b.
They may earn profits when they take positions in options.
c.
They are not subject to the risk of loss on their positions in options.
d.
All of the above are true with respect to market makers.
50. Option trading is regulated by the
a.
Options Clearing Corporation.
b.
International Securities Exchange.
c.
Securities and Exchange Commission.
d.
Federal Reserve.
51. On an exchange, option trades can be executed
a.
by a floor broker.
b.
electronically.
c.
by a market maker.
d.
all of the above
e.
A and B only
52. When investors purchase an option that does not hedge their existing investments, the option can be
referred to as “naked.”
a. True
b. False
53. Backdating implies that CEO (or other executives) reset the date that their options were granted to a
different date when the stock price was lower.
a. True
b. False
54. The motive for a CEO to backdate options is that it allowed them to exercise the options at a lower
exercise price.
a. True
b. False
55. Stock options can be used by speculators to benefit from their expectations and by financial
institutions to reduce their risk.
a. True
b. False
56. The writer of a put option is obligated to provide the specified financial instrument at the price
specified by the option contract if the owner exercises the option.
a. True
b. False
57. A call option is said to be at the money when the market price of the underlying security exceeds the
exercise price.
a. True
b. False
58. Market makers can execute stock option transactions for customers and do not trade stock options for
their own account.
a. True
b. False
59. American-style stock options can be exercised only just before expiration.
a. True
b. False
60. An option with a higher exercise price has a higher call option premium and a lower put option
premium.
a. True
b. False
61. Several call options are available for a given stock, and the risk-return potential will vary among them.
a. True
b. False
62. The greater the existing market price of the underlying financial instrument relative to the exercise
price, the higher the put option premium, other things being equal.
a. True
b. False
63. The longer a call option’s time to maturity, the lower the call option premium, other things being equal.
a. True
b. False
64. The results with covered call writing are better than without covered call writing when the stock
performs poorly and better when the stock performs well.
a. True
b. False
65. Put options are more typically used to hedge when portfolio managers are mainly concerned about a
temporary decline in a stock’s value.
a. True
b. False
66. An increase in uncertainty results in a higher implied standard deviation for the stock, which means
that the writer of an option requires a higher premium to compensate for the anticipated increase in the
stock’s volatility.
a. True
b. False
67. Speculators who anticipate a sharp increase in stock market prices overall may consider purchasing put
options on one of the market indexes.
a. True
b. False
68. Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury
bond futures.
a. True
b. False
69. Speculators sell call options on currencies that they expect to strengthen against the dollar.
a. True
b. False
70. Market makers
a.
can execute stock option transactions for their customers.
b.
can trade options for their own account.
c.
are subject to the risk of losses from their positions in options.
d.
benefit from the spread.
e.
all of the above
71. ____ of options can close out their positions at any time by ____ an identical option.
a.
Sellers; purchasing
b.
Sellers; selling
c.
Buyers; purchasing
d.
none of the above
72. Assuming the same expiration date, an option with a ____ exercise price has a ____ call option
premium and a ____ put option premium.
a.
higher; higher; higher
b.
higher; higher; lower
c.
higher; lower; higher
d.
lower; lower; higher
e.
none of the above
73. Which of the following statements is least correct regarding corporations involved in international
business transactions?
a.
They may purchase currency put options to hedge future receivables denominated in a
foreign currency.
b.
They may purchase currency call options to hedge future payables denominated in a
foreign currency.
c.
They may purchase currency call options to hedge future receivables denominated in a
foreign currency.
d.
They benefit from currency put options if the currency‘s value declines before the
expiration date of the option.
74. The ____ is not a factor affecting the call option premium.
a.
market price of the underlying instrument (relative to option’s exercise price)
b.
volatility of the underlying instrument
c.
current price of futures contracts on the underlying instrument
d.
time to maturity of the call option
75. Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury
bond futures.
a.
purchasing; put
b.
selling; call
c.
purchasing; call
d.
none of the above
76. Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an
exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date,
the price of the Treasury bond futures contract is valued at 93-22. Brad exercises the option and closes
out the position by purchasing an identical futures contract. Brad‘s net gain from this speculative
strategy is $____.
a.
−812.50
b.
4,718.75
c.
−4,718.75
d.
−406.25
e.
none of the above
77. Which of the following statements is incorrect?
a.
Some firms allowed their CEOs to backdate options that they were granted to an earlier
period when the stock price was lower.
b.
Backdating is completely inconsistent with the idea of granting options to encourage
managers to focus on maximizing the stock price.
c.
Firms readily promote their option compensation programs and are more than willing to
acknowledge that the options are an expense.
d.
All of the above are correct.
78. The purchaser of an American-style put option is always better off exercising the option at the
expiration date than before that date.
a. True
b. False
79. Which of the following does not directly affect a call option premium?
a.
volatility of the underlying instrument
b.
market price of the underlying instrument
c.
analyst rating of the underlying instrument
d.
time to maturity of the option
80. Options on small stocks normally have higher premiums than options on large stocks because small
stocks typically are more volatile.
a. True
b. False
81. Which of the following can normally be found in quotations for stock options provided by the
financial media?
a.
exercise price, expiration date, and implied volatility
b.
exercise price, expiration date, and most recently quoted premium
c.
expiration date, implied volatility, and trading volume
d.
expiration date, most recently quoted premium, and implied volatility
82. The CBOE volatility index (VIX):
a.
represents the implied volatility derived from options on the Wilshire 5000 index.
b.
represents the implied volatility derived from options on the S&P 500 index.
c.
is referred to as the “fear index” because low values are perceived to reflect a high degree
of likelihood that stock prices will decline.
d.
B and C