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Indicate whether the statement is true or false.
1. Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury bond futures.
a. True
b. False
2. Market makers can execute stock option transactions for customers but do not trade stock options for their own account.
a. True
b. False
3. The higher 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
4. Options on small stocks normally have higher premiums than options on large stocks because small stocks typically are
more volatile.
a. True
b. False
5. 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
6. The results with covered call writing are better than the results without covered call writing both when the stock
performs poorly and when it performs well.
a. True
b. False
7. When investors purchase an option that does not hedge their existing investments, the option can be referred to as
“naked.”
a. True
b. False
8. 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
9. The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.
a. True
b. False
10. The longer a call option’s time to maturity, the lower the call option premium, other things being equal.
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b. False
11. Speculators sell call options on currencies that they expect to strengthen against the dollar.
a. True
b. False
12. An option with a higher exercise price has a higher call option premium and a lower put option premium.
a. True
b. False
13. Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their
risk.
a. True
b. False
14. 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
15. A key requirement for listing stock options on an exchange is that the trading volume of the underlying stock must
reach a certain minimum level.
a. True
b. False
16. 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
17. Several call options are available for a given stock, and the risk-return potential will vary among them
a. True
b. False
18. 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
19. American-style stock options can be exercised only just before expiration.
a. True
b. False
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20. 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
Indicate the answer choice that best completes the statement or answers the question.
21. 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
22. 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 these are correct.
23. Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of
97-00. The premium paid for the put option is 3-00. Just prior to the expiration date, the price of the Treasury bond futures
contract is valued at 89-00. Brad exercises the option and closes out the position by purchasing an identical futures
contract. Brad’s net gain from this speculative strategy is $____, and his return on his investment is about _______
percent.
a.
b. 11,000; 27
c. −5,000; −167
d.
e. None of these are correct.
24. Corporations involved in international business transactions may purchase ________ to hedge __________
denominated in a foreign currency.
a. currency put options; future receivables
b. currency call options; future payables
c. currency call options; future receivables
d. currency put options; future receivables AND currency call options; future payables
25. 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. Investors are risk averse and will always choose the option that involves the least risk.
d. The variability of a stock’s return is constant.
e. There are no transaction costs involved in trading options.
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26. When the market price of the underlying security exceeds the exercise price, a
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.
27. The premium on an existing put option should ____ when the price of the underlying stock increases.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
28. The premium on an existing put option should ____ when there is an increase in the volatility of the underlying stock.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
29. 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.
30. 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
31. The ____ is not a factor affecting the call option premium.
a. market price of the underlying instrument (relative to the 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
32. ____ can execute transactions desired by investors and trade stock options for their own account.
a. Maintenance brokers
b. Discount brokers
c. Market makers
d. None of these are correct.
33. European-style stock options
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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 these are correct.
34. Speculators who anticipate a decline in interest rates may consider ________ option on Treasury bond futures.
a. purchasing a put option
b. selling a call option
c. purchasing a call option
d. None of these are correct.
35. The premium on an existing put option should ____ when there is a reduction in the volatility of the underlying stock.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
36. 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 a risk of loss on their positions in options.
d. All of these are true with respect to market makers.
37. 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
38. Options trading is regulated by the
a. Options Clearing Corporation.
b. International Securities Exchange.
c. Securities and Exchange Commission.
d. Federal Reserve.
39. The premium on an existing call option should ____ when there is a reduction in the volatility of the underlying stock.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
40. On an options exchange, most option trades are executed
a. electronically.
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b. on the trading floor.
c. by personal phone call.
d. None of the above.
41. Put options are typically used to hedge when portfolio managers are mainly concerned about
a. a permanent decline in a stock’s value.
b. a permanent increase in a stock’s value.
c. a temporary decline in a stock’s value.
d. a temporary increase in a stock’s value.
42. 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 (which will have a face value at
maturity of $100,000) 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 these are correct.
43. The ____, the higher the call option premium, other things being equal.
a. lower the existing price of the underlying security relative to the exercise price
b. lower the volatility of the underlying security’s market price
c. longer the time to maturity of the option
d. lower the existing price of the underlying security relative to the exercise price AND lower the volatility of the
underlying security’s market price
44. Which of the following can normally be found in quotations for stock options?
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
45. When a stock index option is exercised, the cash payment is equal to a specified dollar amount multiplied by
a. the index level.
b. the exercise price.
c. the difference between the index level and the exercise price.
d. the sum of the index level and the exercise price.
46. 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
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47. A speculator purchases a put option on Treasury bond futures with a September delivery date with an exercise 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
48. 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
49. 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 these are correct.
50. 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
51. The premium on an existing call option should ____ when there is an increase in the volatility of the underlying stock.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
52. 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. call option AND put option
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53. Assume an insurance company purchases a call option on a stock index futures contract for a premium of 14, with an
exercise price of 1800. The value of a stock index futures contract is 250 times the index. If the stock 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
54. 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; lower
c. let the option expire; greater
d. let the option expire; lower
e. exercise the option; greater AND let the option expire; lower
55. 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
56. 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 (which will have a face value of $100,000 at
maturity) 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 these are correct.
57. The ____ is the most important exchange for trading options.
a. New York Stock Exchange (NYSE)
b. Chicago Board Options Exchange (CBOE)
c. Boston Options Exchange
d. Nasdaq
58. 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
59. A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified
period of time.
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a. call option
b. put option
c. sale of a futures contract
d. purchase of a futures contract
60. 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. a call on futures.
d. futures on options.
61. 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
62. 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. put; strengthen AND call; weaken
63. 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
64. 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
65. Sellers (writers) of call options can close out 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. selling a put option on the same stock AND buying identical call options.
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66. Which of the following is NOT true regarding options and options on futures contracts?
a. The purchaser of both an option and an option on futures must pay a premium.
b. Options are available on stock indexes, but not on stock index futures.
c. The fulfillment of options on futures contracts is regulated by exchanges, while the fulfillment of options is not.
d. Options are available on stock indexes, but not on stock index futures AND the fulfillment of options on futures
contracts is regulated by exchanges, while the fulfillment of options is not.
67. 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. sell currency call options; payables AND purchase currency put options; receivables
68. The premium on an existing call option should ____ when the price of the underlying stock decreases.
a. be negative
b. decline
c. increase
d. be unaffected
e. be negative AND decline
69. 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
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Answer Key
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