Quiz 1: What Are Derivatives And More

1.

If the owner of a call option with a strike price of $35 finds the stock to be trading for $42 at expiration, then the option:

A.

Expires worthless
B.

Will not be exercised
C.

Is worth $7 per share

Correct Answer
C. Is worth $7 per share

Explanation
If the owner of a call option with a strike price of $35 finds the stock to be trading for $42 at expiration, then the option is worth $7 per share. This is because the owner of the call option has the right to buy the stock at the strike price of $35, but since the stock is trading at $42, they can buy the stock for $35 and immediately sell it for $42, resulting in a profit of $7 per share. Therefore, the option is worth $7 per share.

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2.

What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?

A.

($5)
B.

($2)
C.

$3

Correct Answer
B. ($2)

Explanation
If a call option is purchased for a $5 premium and the stock is valued at $53 at expiration, the option buyer's total profit or loss per share can be calculated by subtracting the exercise price from the stock value and then subtracting the premium paid. In this case, the exercise price is $50 and the premium paid is $5. Therefore, the total profit or loss per share is ($53 - $50) - $5 = $3 - $5 = ($2).

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3.

Which combination of positions will tend to protect the owner from downside risk?

A.

Buy the stock and buy a call option
B.

Sell the stock and buy a call option
C.

Buy the stock and buy a put option

Correct Answer
C. Buy the stock and buy a put option

Explanation
Buying the stock and buying a put option provides protection from downside risk. When an investor buys a stock, they have the potential for profit if the stock price rises. However, by also buying a put option, they have the right to sell the stock at a predetermined price (strike price) within a specific time frame (expiration date). This put option acts as insurance, allowing the investor to limit their potential losses if the stock price declines. Therefore, this combination of positions helps protect the owner from downside risk.

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4.

If you expected a stock to fall but wanted to hold on to the stock due to the voting rights, you would be wise to _____.

A.

Buy a call option
B.

Go long the stock
C.

Buy a put option
D.

Write a put option

Correct Answer
C. Buy a put option

Explanation
Puts go up in value as the underlying asset drops in value

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5.

Which of the following is NOT correct?

A.

A call gives you the right and the obligation to buy the underlying asset
B.

A put gives you the right, but not the obligation to sell the underlying asset
C.

Being short an option creates an obligation
D.

The profit for a call holder is less than the payoff

Correct Answer
A. A call gives you the right and the obligation to buy the underlying asset

Explanation
A call option gives the holder the right, but not the obligation, to buy the underlying asset at a specified price within a certain time period. Therefore, the statement "A call gives you the right and the obligation to buy the underlying asset" is incorrect.

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6.

Forwards and futures are similar in many ways, however not in all ways. Which of the following is true?

A.

Forwards have daily cash settlement.
B.

Forwards are more apt to be exchange traded
C.

Futures are less standardized
D.

Futures are easier to trade

Correct Answer
D. Futures are easier to trade

Explanation
Futures contracts are traded on organized exchanges, such as the Chicago Mercantile Exchange (CME), which provides a centralized marketplace for buyers and sellers to trade these contracts. This makes futures contracts more easily accessible and tradable for investors compared to forwards, which are typically traded over-the-counter (OTC) and involve direct agreements between two parties. The standardized nature of futures contracts also contributes to their ease of trading, as it allows for liquidity and price transparency.

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7.

The payoff to a long futures contract is _______.

A.

Most similar to the payoff to a call contract, but the futures payoff can also be negative.
B.

Most similar to the payoff to a put contract, but the futures payoff can also be negative.
C.

Most similar to writing a call contract. (being short a call).
D.

A line that slopes down from left to right at a 45% angle.

Correct Answer
A. Most similar to the payoff to a call contract, but the futures payoff can also be negative.

Explanation
A long futures contract gives the holder the right to buy an underlying asset at a predetermined price in the future. The payoff to a long futures contract is most similar to the payoff to a call contract because both involve the potential for unlimited gains if the price of the underlying asset increases. However, the futures payoff can also be negative if the price of the underlying asset decreases, which is not the case for a call contract.

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8.

Suppose you write a call contract for $4 a share on XYZ stock with a strike of $25. What is you PROFIT of this position if stock at expiration is $24?

A.

A loss of $400 (4 dollars per share * 100 shares per contract)
B.

A gain of $400 ($4 per share * 100 shares per contract)
C.

Impossible to tell since you do not the price of the call when you sold it.
D.

$300 (400 - 100)

Correct Answer
B. A gain of $400 ($4 per share * 100 shares per contract)

Explanation
If the stock at expiration is $24, the call contract will not be exercised because the stock price is below the strike price of $25. As a result, the call contract will expire worthless and the seller of the call contract will keep the premium received, which is $4 per share multiplied by 100 shares per contract, resulting in a gain of $400.

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9.

Suppose the following: Strike price is $25, stock price is $30. The option expires tomorrow. Which of the following is true?

A.

A put contract with the above facts is "in the money"
B.

A call contract with the above facts is "out of the money"
C.

The value of the option would be slightly greater than its intrinsic value
D.

More than one of the above is true

Correct Answer
C. The value of the option would be slightly greater than its intrinsic value

Explanation
In this scenario, a put contract with a strike price of $25 and a stock price of $30 would be "in the money" because the stock price is higher than the strike price, allowing the holder of the put option to sell the stock at a higher price than the market value. On the other hand, a call contract with the same strike price and stock price would be "out of the money" because the stock price is higher than the strike price, making it less valuable to exercise the option to buy the stock at a higher price. Therefore, the correct answer is that the value of the option would be slightly greater than its intrinsic value, considering the difference between the option's market value and its intrinsic value.

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10.

Suppose the following: Strike price is $25, stock price is $30. The option expires in two hours. Which of the following is true?

A.

If the contract is a call option, its payoff if exercised now is $5.00
B.

If the contract is a put option, it can not be profitably exercised at present.
C.

If it is a put option, you would let it expire worthless.
D.

More than one of the above are true

Correct Answer
D. More than one of the above are true

Explanation
The given answer is correct because both statements "If the contract is a call option, its payoff if exercised now is $5.00" and "If it is a put option, you would let it expire worthless" are true. In this scenario, if the contract is a call option, the holder can exercise it and buy the stock at the strike price of $25, then immediately sell it at the market price of $30, resulting in a payoff of $5. On the other hand, if the contract is a put option, it would not be profitable to exercise it since the stock price is higher than the strike price, so it would be more advantageous to let it expire worthless.

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11.

Suppose you own 3000 shares of ABC company stock. You believe the stock is likely to fall. You decide to write call contracts on the shares and buy put contracts. (full coverage in each direction). Suppose the call price is $4 and the put price is $2. (different strikes). Further suppose that each contract ends up out of the money. What is your net profit (loss) from the trades?

A.

$18,000 profit
B.

$12,000 loss
C.

$$12,000 gain
D.

None of the above

Correct Answer
D. None of the above

Explanation
$6000 is the right answer. From the calls: $4* 3000 = 12,000 but you also bought puts 3000 * $2 . So 12,000 - 6,000

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12.

If you are looking to hedge your short position in oil, which of the following would be the best alternative?

A.

Shorting a call option on oil
B.

Buying a call option on oil
C.

Writing a put option on oil
D.

Selling an oil futures contract

Correct Answer
B. Buying a call option on oil

Explanation
Buying a call option on oil would be the best alternative to hedge a short position in oil. A call option gives the holder the right, but not the obligation, to buy the underlying asset (in this case, oil) at a specified price (strike price) within a certain period of time. By buying a call option, the investor can protect themselves from potential losses if the price of oil increases. If the price of oil rises above the strike price, the investor can exercise the call option and buy oil at a lower price, offsetting their short position.

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13.

Which one do you like?

A.

Option 1
B.

Option 2
C.

Option 3
D.

Option 4

Correct Answer
A. Option 1