Chapter 17 An Introduction to Options
TRUE/FALSE
call option) is the difference between the price of the stock
and the per share exercise price of the option.
option‘s intrinsic value.
is issued.
selling in two markets to take advantage of price
differentials.
less than its intrinsic value.
for less than its strike price, an opportunity for arbitrage
exists.
opportunity to establish an arbitrage position.
sell for a time premium.
option‘s potential leverage.
for an option to buy stock increases.
its stock at a specified price within a specified time
period.
these securities are considered to be conservative
investments.
paid to the company’s stockholders.
selling the call.
time premium paid for the stock.
within a specified time period.
usually for less than a year.
individuals.
options.
price minus the stock’s price.
stock’s price.
naked call options
price of the stock declines.
price of the stock rises.
call option.
the price of the underlying stock.
to rise.
a stock short.
dividends paid by the firm.
within a specified time period.
the underlying stock.
buy put options.
federal income taxation.
minus the put’s strike price.
maximum price.
option profits.
purchasing a stock and a put option.
stocks, there are also options on the market as a whole
(i.e., an index).
a stock index call option.
hedge the portfolio by purchasing a stock index call option.
increase, that individual should sell an option to buy
Treasury bonds
will profit if the market rises.
option can lose is the cost of the option.
is the cost of the option.
position in the market without having to select individual
stocks.
MULTIPLE CHOICE
a. its price
b. its strike price
c. the difference between the stock’s price and the
option‘s strike price
d. the difference between the option‘s strike price
and the option‘s price
a. the minimum price of an option
b. the maximum price of an option
c. neither an option‘s minimum nor its maximum price
d. both the maximum and the minimum price of an option
a. the strike price increases and the price of the
stock declines
b. the strike price increases and the price of the
stock rises
c. the strike price decreases and the price of the
stock declines
d. the strike price decreases and the price of the
stock rises
a. exceeds its intrinsic value
b. is less than its intrinsic value
c. cannot be less than its intrinsic value
d. cannot be greater than its intrinsic value
a. potential leverage
b. potential income
c. safety of principal
d. liquidity
value because
a. they earn dividends
b. they are debt obligations
c. they offer potential leverage
d. they are long-term investments
a. individuals
b. firms
c. governments
d. investor
a. an expiration date
b. a specified exercise price
c. the right to receive dividends
d. a strike price
is affected by
a. the length of time to expiration
b. the firm’s credit rating
c. the existence of a rights offering
d. the firm’s financial statements
a. there is no limit to the potential profit
b. risk is increased
c. risk is reduced
d. the term of the position is increased
a. sell stock at a specified price
b. buy stock at a specified price
c. deliver stock at a specified price
d. deliver bonds at a specified price
a. the strike price is fixed
b. it may be issued by individual investors
c. it is not marketable (saleable)
d. it receives dividend payments
a. potential leverage
b. liquidity
c. income
d. safety of principal
1. the strike price
2. the price of the underlying stock
3. the term (i.e., life) of the call
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
1. a secondary market in put and call options
2. a division of the SEC that regulated option trading
3. the first organized options exchange
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
option is
a. potential leverage
b. safety of principal
c. income received
d. liquidity
a. purchasing the stock
b. selling the stock
c. purchasing the option
d. selling the option
a. the prices of the stock and the call to rise
b. the prices of the stock and the call to fall
c. the prices of the stock to fall and the call to rise
d. the prices of the stock to rise and the call to
remain stable
a. buy stock
b. receive stock
c. sell stock
d. receive dividends
a. stock rises
b. a call falls
c. stock falls
d. a call rises
the investor who wrote a covered call
1. earns a modest profit
2. sustains a modest loss
3. lost an opportunity for a large profit
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. only 3
1. the strike price
2. the price of the stock
3. the term on the put
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
1. permit the investor to short the market instead
of individual stocks
2. require delivery of an index of stocks
3. limit the buyer’s potential loss to the cost of
the option
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
prices?
a. buying a stock index call
b. buying a stock index put
c. buying a stock and selling a call
d. buying a stock and selling a put
1. buying a stock index call
2. buying a stock index put
3. selling a stock index call
4. selling a stock index put
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
PROBLEMS
1. What are the following call options’ intrinsic values
and time premiums if the price of the underlying stock is
$55?
Option strike price Price of the call
Call at $50 $7.00
Call at $55 3.00
Call at $60 0.50
2. A put and a call have the following terms:
Call: strike price $50
expiration date six months
Put: strike price $50
expiration date six months
The price of the stock is currently $55. The price of the
call and put are, respectively, $9 and $1. What will be the
profit from buying the call or buying the put if, after six
months, the price of the stock is $40, $50, or $60?
3. What are the intrinsic values and time premiums of the
following call options if the price of the underlying stock
is $35? What are the profits and losses to the buyers and
the writers if the stock sells for $31 at the options’
expiration?
Strike Price Price of the Option
$30 $7.50
$35 $3.00
4. A warrant is the option to buy one share of stock at
$40. It expires after one year and currently sells for $10.
The price of the stock is $32. What is the maximum possible
profit if an investor buys one share of stock and shorts
one warrant? What is the range of stock prices that yields
a profit on this position?
5. Given the following information,
price of a stock $50
strike price of a six-month call $45
market price of the call $9
finish the following sentences:
a. The intrinsic value of the call is _________.
b. The time premium paid for the call is ________.
c. If an investor established a covered call position, the
amount invested is _________.
d. The most the buyer of the call can lose is ________.
e. The maximum amount the seller of the call naked can lose
is ________.
f. which call is “in” or “out” of the money?
After six months (i.e., at the expiration date of the call),
the price of the stock is $52.
g. The profit (loss) from buying the call is ________.
h. The price (loss) from selling the call naked is _______.
i. The profit (loss) from selling the call covered is
__________.
j. The profit (loss) from selling the stock short six months
earlier is _________.
k. At expiration the time premium paid for a put or a call is
_________.
6. Given the following information,
price of a stock $39
strike price of a six-month call $35
market price of the call $8
strike price of a six-month put $40
market price of the put $3
finish the following sentences.
a. The intrinsic value of the call is _________.
b. The intrinsic value of the put is _________.
c. The time premium paid for the call is _________.
d. The time premium paid for the put is _________.
At the expiration of the options (i.e., after six months have
lapsed), the price of the stock is $45.
e. The profit (loss) from buying the call is _______.
f. The profit (loss) from writing the call covered (i.e.,
buying the stock and selling the call) is ________.
g. The profit (loss) from buying the put is _______.
h. The profit (loss) from selling the stock short is ______.
i. The maximum possible loss from buying the put is ______.
j. At expiration, the maximum price commanded by a put or a
call is _______.
7. A put is the option to sell stock at $35. The price of
the stock is $34, and the price of the put is $2.
a. What is the intrinsic value of the put?
b. What is the time premium paid for the put?
c. What is the percentage return from purchasing the put if
at the expiration of the put the price of the stock is $31?
8. A three-month call option with a strike price of $30 is
currently selling for $4 when the price of the underlying
stock is selling for $32.
a. What is the call’s intrinsic value?
b. What is the time premium?
c. What is the maximum possible loss to the buyer of the
call?
d. What is the maximum possible profit to the seller of the
option?
e. Would you buy the call if you expected the price of the
stock to fall?
Three months later the stock is selling for $39.
f. What is your profit or loss from buying the stock?
g. What is the option’s intrinsic value?
h. What is your profit or loss from selling the call?
i. If you let the option expire, what do you receive?
j. What are the percentage returns you earned on investments
in the call and in the stock?
k. If the price of the stock had been $30 at the option’s
expiration, what would have been the percentage returns on
investments in the call and in the stock?
l. What is the primary reason for purchasing a call instead
the underlying stock?
9. Answer the questions given the following information:
price of a stock $52
strike price of a three–month call $50
market price of the call $4.
a. Is the call “out” of the money?
b. What is the time premium paid for the call?
c. What is the maximum possible loss from buying the call?
d. What is the maximum profit the buyer of the call can
earn?
e. What is the maximum profit the seller of the call can
earn?
f. What price of the stock will assure that the buyer of
the call will not sustain a loss?
g. If an investor sells the call covered, what is the cash
inflow or cash outflow?
After three months (i.e., at the expiration of the
options), the price of the stock is $53.
h. What is the profit or loss from buying the call?
i. What is the profit or loss from selling the call naked?
j. At expiration, what is the time premium paid for the
call?
10. You obtain the following information concerning a stock,
a call option, and a put option
Price of the stock $42
Strike price (both options) $40
Price of the call $6
Price of the put $3
Expiration date three months
You want to purchase the stock but also want to use an
option to reduce your risk of loss.
a. Do you purchase the put or the call or do you sell the
put or the call?
b. What is the cash inflow or outflow from your position?
c. What is profit or loss if the price of the stock
stagnates and trades for $42 after three months?
d. What is profit or loss if the price of the stock trades
for $50 or $100 after three months?
e. What is profit or loss if the price of the stock trades
for $30 after three months?
f. What is the worst case scenario?
g. If you want to retain the position, what must be done
after three months have passed?
SOLUTIONS TO PROBLEMS
