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CHAPTER 7: ADVANCED OPTION STRATEGIES
MULTIPLE CHOICE TEST QUESTIONS
The following prices are available for call and put options on a stock priced at $50. The risk-free rate is 6 percent and
the volatility is 0.35. The March options have 90 days remaining and the June options have 180 days remaining. The
Black-Scholes model was used to obtain the prices.
Calls
Puts
Strike
March
June
March
June
45
6.84
8.41
1.18
2.09
50
3.82
5.58
3.08
4.13
55
1.89
3.54
6.08
6.93
Use this information to answer questions 1 through 20. Assume that each transaction consists of one contract (for 100
shares) unless otherwise indicated.
For questions 1 through 6, consider a bull money spread using the March 45/50 calls.
1. How much will the spread cost?
a. $986
b. $302
c. $283
d. $193
e. none of the above
2. What is the maximum profit on the spread?
a. $500
b. $802
c. $198
d. $302
e. none of the above
3. What is the maximum loss on the spread?
a. $500
b. $698
c. $198
d. $802
e. none of the above
4. What is the profit if the stock price at expiration is $47?
a. -$102
b. $398
c. -$302
d. $500
e. none of the above
5. What is the breakeven point?
a. $48.02
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b. $41.98
c. $55.66
d. $50.00
e. none of the above
6. Suppose you closed the spread 60 days later. What will be the profit if the stock price is still at $50?
a. $41
b. $198
c. $302
d. $102
e. none of the above
For questions 7 and 8, suppose an investor expects the stock price to remain at about $50 and decides to execute a
butterfly spread using the June calls.
7. What will be the cost of the butterfly spread?
a. $1,195
b. $637
c. $79
d. $1,045
e. none of the above
8. What will be the profit if the stock price at expiration is $52.50?
a. $171
b. $1,421
c. $1.037
d. $421
e. none of the above
9. Suppose you wish to construct a ratio spread using the March and June 50 calls. You want to buy 100 June 50
call contracts. How many March 50 calls would you sell?
a. 105
b. 95
c. 100
d. 57
e. none of the above
Answer questions 10 and 11 about a calendar spread based on the assumption that stock prices are expected to remain
fairly constant. Use the June/March 50 call spread. Assume one contract of each.
10. What will the spread cost?
a. -$176
b. $176
c. $558
d. $105
e. none of the above
11. What will be the profit if the spread is held 90 days and the stock price is $45?
a. $36
b. $20
c. $558
d. –$20
e. none of the above
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Answer questions 12 through 17 about a long straddle constructed using the June 50 options.
12. What will the straddle cost?
a. $145
b. $690
c. $971
d. $413
e. none of the above
13. What are the two breakeven stock prices at expiration?
a. $55.58 and $45.87
b. $54.13 and $45.87
c. $55.58 and $44.42
d. $59.71 and $40.29
e. none of the above
14. What is the profit if the stock price at expiration is at $64.75?
a. -$971
b. $1,475
c. -$3,525
d. $500
e. none of the above
15. What is the profit if the position is held for 90 days and the stock price is $55?
a. -$971
b. –$58
c. -$109
d. -$471
e. none of the above
16. Suppose the investor adds a call to the long straddle, a transaction known as a strap. What will this do to the
breakeven stock prices?
a. lower both the upside and downside breakevens
b. raise both the upside and downside breakevens
c. raise the upside and lower the downside breakevens
d. lower the upside and raise the downside breakevens
e. none of the above
17. Suppose a put is added to a straddle. This overall transaction is called a strip. Determine the profit at
expiration on a strip if the stock price at expiration is $36.
a. -$129
b. $1,416
c. $429
d. $1,384
e. none of the above
Answer questions 18 through 20 about a long box spread using the June 50 and 55 options.
18. What is the cost of the box spread?
a. $500
b. $2,018
c. $76
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d. $484
e. none of the above
19. What is the profit if the stock price at expiration is $52.50?
a. $16
b. $500
c. –$234
d. $250
e. none of the above
20. What is the net present value of the box spread?
a. $9.84
b. $5.00
c. $16.00
d. $1.84
e. none of the above
21. Which of the following strategies does not profit in a rising market?
a. put bull spread
b. long straddle
c. collar
d. call bull spread
e. none of the above
22. Which of the following transactions can have an unlimited loss?
a. long straddle
b. calendar spread
c. butterfly spread
d. reverse box spread
e. none of the above
23. Which of the following is the best strategy for an expected fall in the market?
a. long strip (2 puts and 1 call)
b. put bull spread
c. calendar spread
d. butterfly spread
e. none of the above
24. Early exercise is a disadvantage in which of the following transactions?
a. short box spread
b. put bear spread
c. long strip (2 puts and 1 call)
d. long strap (2 calls and 1 put)
e. none of the above
25. Which of the following have similar profit graphs?
a. call bull spread and long box spread
b. put bear spread and short box spread
c. butterfly spread and ratio spread
d. calendar spread and call bear spread
e. none of the above
26. The purchase of one option and the sale of another is known as
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a. box
b. bear strategy
c. bull strategy
d. collar
e. spread
27. The option strategy where the holder of a long position in a stock buys a put with an exercise price lower than
the current stock price and sells a call with an exercise price higher than the current stock price is known as
a. box
b. bear strategy
c. bull strategy
d. collar
e. spread
28. The profit from a put bear spread strategy when both options are out of the money is
a. –X1 + ST + P1 + X2 – ST – P2
b. –X1 + ST + P1 – P2
c. X1 – ST – P1 – X2 + ST + P2
d. P1 + X2 – ST – P2
e. P1 – P2
29. “Like the butterfly spread, the calendar spread is one in which the underlying instrument’s ___________ is the
major factor in its performance.” The best word for the blank is which of the following?
a. volatility
b. expected rate of return
c. beta
d. correlation with the benchmark index
e. skewness
30. Which of the following statements best describes the nature of option time value decay?
a. time value decays more rapidly as the stock price approaches being at-the-money
b. time value decays more rapidly as expiration approaches
c. time value decays more rapidly for put option than call options
d. time value decay does not occur for collar option strategies
e. time value decay is detrimental for a trader who is short call options
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CHAPTER 7: ADVANCED OPTION STRATEGIES
TRUE/FALSE TEST QUESTIONS
T F 1. A spread that is profitable if the options are in-the-money is called a money spread.
T F 2. Buying a put money spread is a bearish strategy.
T F 3. In a calendar spread the time value of the nearby option will decay more rapidly.
T F 4. A call bear spread is a strategy for investors who expect stock prices to increase.
T F 5. A call money spread that is closed prior to expiration has lower losses but higher profits for
each stock price than if held to expiration.
T F 6. There are three breakeven stock prices in a butterfly spread.
T F 7. Early exercise is an important risk when call bear spreads and put bull spreads are used.
T F 8. A call butterfly spread combines a call bull spread with a call bear spread.
T F 9. A call butterfly spread is a bullish strategy that is profitable if stock prices increase.
T F 10. A reverse calendar spread is used to take advantage of unexpected high volatility.
T F 11. One of the risks of a calendar spread is that the intrinsic values may be different.
T F 12. The holder of a straddle does not care which way the market moves as long as it makes a
significant move.
T F 13. If a straddle is closed prior to expiration, the investor can recover some of the time value of
either the call or the put but not both.
T F 14. An investor who holds a strap (2 calls and 1 put) believes the market is more likely to go up
than down.
T F 15. A strip (2 puts and one call) would cost more than a straddle but would pay off more if the
stock falls.
T F 16. The payoffs form a straddle are more like the payoffs from a money spread than a calendar
spread.
T F 17. The risk of early exercise is of no concern to the holder of a long straddle.
T F 18. At the expiration of a box spread, at most there will be only one option exercised.
T F 19. A box spread is a combination of a call bull spread and a put bear spread.
T F 20. A box spread is a good strategy to use if high volatility is expected.
T F 21. The delta of a straddle would be the call delta plus the put delta.
T F 22. A strap is a less expensive bullish strategy than a straddle.
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T F 23. A collar gives downside protection, leaving the upside open.
T F 24. A ratio spread can be conducted with money spreads or time spreads.
T F 25. To truly gain from a straddle, an investor must have a better estimate of volatility than
everyone else.
T F 26. A spread option strategy is a transaction in one option and an opposite transaction in the
underlying instrument.
T F 27. The profit from a collar option strategy when the terminal stock price ends up in between
the two strike prices is ST – S0 – P1 + C2 where X2 > X1.
T F 28. The longer an investor holds a long call butterfly spread position, everything else the same,
the greater the distance between the breakeven stock prices.
T F 29. The breakeven points for a long straddle strategy are equidistant from the current stock
price regardless of the chosen strike price.
T F 30. The profit from a zero-cost collar option strategy when the terminal stock price ends up in
between the two strike prices is ST – S0 where X2 > X1.
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CHAPTER 7