Fundamentals of Investing, 11e (Gitman/Joehnk/Smart)
Chapter 14 Options: Puts and Calls
14.1 Learning Goal 1
1) Because puts and calls derive their value from the behavior of some other real or financial
asset, they are known as derivative securities.
2) Investors who purchase options acquire nothing more than the right to buy or sell the shares of
the underlying security.
3) Options are created by investors.
4) Puts and calls are issued by the same corporation that issued the underlying stock.
5) Rights are call options issued to current owners of the stock and normally expire within a
short period of time.
6) Warrants are short-term options usually expiring within a year or less.
7) Warrants are options that are attached to bond issues to make the bonds more attractive to
investors.
8) Rights are long-term call options attached to bonds while warrants are short-term call options
attached to stock.
9) Purchasers of stock options
A) own a financial asset with benefits of firm ownership.
B) have a claim on the profits of the firm issuing the underlying securities.
C) have the obligation to buy or sell a predetermined amount of shares at the strike price.
D) have the right to buy or sell a certain number of underlying shares.
10) Which one of the following statements concerning options is correct?
A) One option covers 1,000 shares of stock.
B) A put gives the option holder the right to buy a stated amount of securities.
C) The owner of a call is entitled to the dividends paid on the underlying shares of stock.
D) Option holders can profit on movements of the price of the underlying security.
11) Which of the following statements concerning options are correct?
I. Options are derivative securities.
II. The value of an option is dependent upon the value of the underlying security.
III. The seller of the option retains the option premium whether or not the option is exercised.
IV. Options can provide leverage benefits.
A) II and III only
B) I, II and III only
C) I, II and IV only
D) I, II, III and IV
12) Which of the following is true about rights?
A) They are usually attached to bonds as a “sweetener”
B) The owner has several years in which to exercise the option.
C) They are a type of short-lived call option.
D) They are a type of short-lived put option.
13) The maker of a put or call is the
A) company which issued the underlying security.
B) person who facilitates the trade on the floor of the exchange.
C) party who writes the option.
D) party who decides whether or not the option is exercised.
14) One reason that writing options can be a viable and profitable investment strategy is that
A) the option writer collects the quarterly dividends.
B) most options expire unexercised.
C) an option writer determines when the option is exercised.
D) an option writer can exercise the option to avoid a potential loss.
15) The ability to obtain a given equity position at a reduced capital investment, and therefore
magnify returns, is known as
A) leverage.
B) straddling.
C) hedging.
D) triple witching.
16) LEAPS are a special type of option
A) that must be exercised within six months.
B) that can only be exercised on the expiration date.
C) that cannot be exercised for at least a year after it is is purchased.
D) that may have an expiration date as long as three years.
17) Warrants are generally created when
A) a firm decides to execute a stock split.
B) the issuing corporation decides to sweeten a bond issue.
C) a LEAP expires and automatically converts.
D) a financial institution decides to create them based on market conditions.
18) Warrants
A) provide substantially less capital appreciation potential than the underlying stock.
B) tend to be quite costly.
C) have a stipulated price and an expiration date.
D) are not traded in the secondary markets because of their low unit costs.
14.2 Learning Goal 2
1) Many options expire without being exercised.
2) American style options can only be exercised on their expiration dates.
3) The party that accepts the legal obligation to stand behind the option is the buyer of the
contract.
4) Listed options trade over-the-counter.
5) Over-the-counter options are less structured than listed options and are primarily purchased by
individual investors.
6) The majority of today’s options are stock options traded primarily on the CBOE and on
AMEX.
7) Technically, listed options expire on the Saturday following the third Friday of the expiration
month.
8) European options can only be sold on the expiration date.
9) Standardized options expire on the last business day of the expiration month.
10) The buyer of a listed American option has which of the following rights?
I. the right to change the expiration date
II. the right to change the strike price
III. the right to resell the option
IV. the right to let the option expire unexercised
A) I and III only
B) III and IV only
C) I, III and IV only
D) II, III and IV only
11) The writer of a put
A) accepts the obligation to sell a predetermined number of shares at a predetermined price.
B) is betting the price of the underlying security will increase in value.
C) is hoping that the put will be in-the-money prior to expiration.
D) will pay the premium whether or not the option is exercised.
12) Which of the following is a possible official expiration date for a standardized option
contract?
A) Saturday, October 17
B) Monday, March 1.
C) Friday, April 30
D) Wednesday, May 19.
6
13) Which one of the following was the first listed exchange for stock options in the United
States?
A) Stock Index Board
B) Philadelphia Board of Trade
C) New York Stock Exchange
D) Chicago Board Options Exchange
14) The strike price of a put option is the price
A) an investor must pay for the options contract.
B) of the underlying stock at the time that the options contract is purchased.
C) the price at which the underlying stock can be sold.
D) the price at which the underlying stock can be bought.
15) Listed options
A) are traded directly between the buyer and the seller.
B) are rarely traded in the secondary markets.
C) have readily available price information.
D) are sold over the counter.
16) Stocks options that trade in the January cycle will have contracts available that expire in
A) January, February, April, and July.
B) March, June, September, December.
C) January, February, March, and April.
D) each of the next 12 months.
17) The two provisions which investors should carefully consider when evaluating stock options
are the
A) strike price and the exchange ratio.
B) time until expiration and the strike price.
C) leverage ratio and the time to maturity.
D) premium and the discount.
18) For a call purchased on an organized security exchange, the strike price specifies the
A) contractual price at which each of the shares of the underlying stock can be bought.
B) prevailing market price of one share of the underlying stock.
C) cost of buying one option contact based on the value of the underlying stock.
D) intrinsic value of the offsetting put.
19) For all practical purposes, listed stock options always expire
A) on the last business day of the expiration month.
B) on the first Monday of every calendar quarter.
C) on the third Friday of the expiration month.
D) three months from the date of the option purchase.
14.3 Learning Goal 3
1) The buyer of a put expects the price of the underlying stock to rise.
2) The value of a call increases as the price of the underlying security rises.
3) The value of a put increases as the price of the underlying security rises.
4) The option premium is the price of the option.
5) The price behavior of the underlying security is the primary determinant of the price of an
option.
6) A put option has a strike price of $32. The current price of the stock is $34. The put option is
said to be “in-the-money.”
7) Grant purchased one call on XYZ stock at an exercise price of $25. The market price of XYZ
stock when Grant purchased the call was $24 a share. XYZ is currently priced at $30 a share.
Grant paid $120 to buy the call. How much profit will Grant make if he exercises the option
today and then sells the shares? Ignore all transaction-related costs.
A) $380
B) $480
C) $500
D) $600
8) Rex bought a put on Alpha stock with a strike price of $35 when the market price of Alpha
stock was $33 a share. Alpha is currently selling at $34 a share. Which of the following
statements are true given this information?
I. Rex’s option is worth at least $100 today.
II. Rex’s option is worthless today.
III. Rex’s option has more value today than when he bought it.
IV. Rex’s option has less value today than when he bought it.
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
9) One of the major disadvantages of options is
A) their lifespan.
B) their cost.
C) their lack of liquidity.
D) the risk to option buyers.
10) The most important factor affecting the market price of a put or call is the
A) market interest rate.
B) expiration date.
C) price behavior of the underlying common stock.
D) price behavior of the corresponding warrant.
11) NZMA stock is currently selling for $128. Which of the following options is “in-the-
money”?
A) March 130 call
B) February 125 call
C) March 125 put
D) February 100 put
12) Which of the following affect the value of puts and calls written on shares of common stock?
I. price volatility of the underlying stock
II. current market price of the underlying stock
III. length of time until the option expiration date
IV. current market interest rate
A) I and II only
B) I, II and III only
C) II, III and IV only
D) I, II, III and IV
13) Lew paid $300 to purchase a call on Delta stock with a strike price of $25. What does the
market price of Delta have to be for Lew to break-even on his option investment? Ignore
transaction costs and taxes.
A) $22
B) $25
C) $28
D) Cannot be determined from the information provided
14) Andrea wrote a three-month call on Echo stock. The option cost $200 and the strike price
was $10. What does the market price of Echo have to be for Andrea to break-even on this
investment if the option is exercised? Ignore transaction construed taxes.
A) $10
B) $12
C) $8
D) Cannot be determined from the information provided
15) Jason purchased a six-month put on ABC stock at a cost of $100. The strike price was $15.
At what market price does Jason just break-even on this investment? Ignore transaction costs and
taxes.
A) $15
B) $16
C) $14
D) Cannot be determined from the information provided
16) Jaime wrote a nine-month put on Beta stock. The strike price was $25 and the market price at
the time the option was written was $24. The total price of the option was $150. At what market
price will Jamie just break-even on this investment? Ignore transaction costs and taxes.
A) $23.50
B) $24.00
C) $25.00
D) $26.50
17) A put has fundamental value as long as
A) the market price of the underlying financial asset has a positive value.
B) the market price of the underlying financial asset is less than the strike price.
C) the strike price of the put is greater than the time premium of the put.
D) the strike price of the put is less than the market value of the underlying asset.
18) What is the fundamental value of a call with a strike price of $30 and a market price of $33?
A) -$300
B) -$3
C) $3
D) $300
19) Which of the following represent in-the-money options?
I. a call when the market price exceeds the strike price
II. a call when the strike price exceeds the market price
III. a put when the market price exceeds the strike price
IV. a put when the strike price exceeds the market price
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
20) What is the time premium of a put with a strike price of $25 when the option price is $2 and
the underlying common stock sells for $24?
A) $100
B) $200
C) $300
D) $400
21) What is the fundamental value of a put contract with a strike price of $25 when the option
price is $1.50 and the underlying common stock sells for $26?
A) $150
B) $100
C) $0.00
D) -$100
22) Which of the following increase(s) the time premium of a call option?
I. a market price that exceeds the strike price
II. increasing volatility in the market price of the underlying security
III. decreasing market interest rates
IV. decreasing the time to option expiration
A) II only
B) I and II only
C) III and IV only
D) II and III only
23) 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?
14.4 Learning Goal 4
1) Options can provide a lot of price action for a limited dollar investment.
2) One of the primary advantages of options is the leverage they provide.
3) The maximum amount the buyer of a put can lose is the cost of the option.