Test 1: Chapters 1-4
Option basics
Questions and Answers
- 1.
By _____ a trade a broker is able to collect double commission.
Explanation
By crossing a trade, a broker is able to collect double commission. This means that the broker facilitates a transaction between two clients within their own firm, allowing them to earn commission from both parties involved in the trade. This practice can be seen as unethical as it may create conflicts of interest and prioritize the broker's financial gain over the best interests of their clients.Rate this question:
- 2.
If a trader is primarily concerned with trading a certain quantity of the asset and is less sensitive to the price at which it trades, they should use a _____ order.
Explanation
If a trader is primarily concerned with trading a certain quantity of the asset and is less sensitive to the price at which it trades, they should use a market order. A market order is an instruction to buy or sell an asset immediately at the best available current price. It ensures that the desired quantity of the asset is traded without specifying a specific price. This type of order is suitable for traders who prioritize executing the trade quickly and efficiently, rather than obtaining the best possible price.Rate this question:
- 3.
The difference between the trade price and current fair value of an option is referred to in our industry as _____
Explanation
The difference between the trade price and current fair value of an option is commonly known as "edge" in our industry. This term is used to describe the advantage or profit potential that a trader can gain from the price disparity between the option's trade price and its actual value. By understanding and capitalizing on this edge, traders can make informed decisions and potentially maximize their returns.Rate this question:
- 4.
You can imagine an options market maker like a casino taking bets at a roullette wheel. The optimal situation is in which a better enters the casino and places his entire bet on one number.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The explanation for the correct answer, False, is that an options market maker is not like a casino taking bets at a roulette wheel. While a casino profits from gamblers losing their bets, an options market maker profits from the bid-ask spread and providing liquidity to the market. The optimal situation for an options market maker is not when a better places his entire bet on one number, but rather when there is a balance of buyers and sellers in the market.Rate this question:
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- 5.
By collecting the difference between the bid/offer and fair value, you make riskless money.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The statement suggests that by collecting the difference between the bid/offer and fair value, one can make riskless money. However, this is not true. The bid/offer spread represents the difference between the buying and selling prices of a security, and the fair value is the estimated worth of the security. While there may be opportunities to profit from market inefficiencies, there is always a level of risk involved in trading securities. Therefore, it is not accurate to claim that collecting the difference between bid/offer and fair value guarantees riskless money.Rate this question:
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- 6.
A _______ _____ is when the clearing firm asks you to put up more capital to cover your position.
Correct Answer
margin callExplanation
A margin call occurs when the clearing firm requires an investor to provide additional funds to cover their position. This is typically necessary when the value of the investor's assets falls below a certain threshold, known as the maintenance margin. By requesting more capital, the clearing firm aims to protect itself from potential losses and ensure that the investor can fulfill their financial obligations.Rate this question:
- 7.
The price at which a transaction will occur should the owner of an option choose to exercise is known as the _____ price.
Correct Answer
strikeExplanation
The price at which a transaction will occur should the owner of an option choose to exercise is known as the strike price. This is the predetermined price at which the underlying asset can be bought or sold by the option holder. It is an essential component in options trading as it determines the potential profitability of the option.Rate this question:
- 8.
The date by which the owner of an option must make the decision of whether or not to exercise, and after which the option no longer exists is known as the _____.
Correct Answer
expiration date, expiration, expiry, expiry dateExplanation
The date by which the owner of an option must make the decision of whether or not to exercise, and after which the option no longer exists is known as the expiration date, expiry, or expiry date. This is the date at which the option contract ceases to be valid and the owner loses the right to exercise the option.Rate this question:
- 9.
A short put is a bet that the underlying will _____. (may select multiple answers)
- A.
Increase
- B.
Decrease
- C.
Remain unchanged
Correct Answer(s)
A. Increase
C. Remain unchangedExplanation
A short put is a type of options strategy where the investor sells a put option with the expectation that the underlying asset will either increase or remain unchanged in value. By selling the put option, the investor is obligated to buy the underlying asset at a predetermined price (the strike price) if the option is exercised by the buyer. If the underlying asset increases in value, the investor keeps the premium received from selling the put option. If the underlying asset remains unchanged, the investor also keeps the premium. Therefore, the correct answers are "increase" and "remain unchanged".Rate this question:
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- 10.
Regular equity options expire when?
- A.
The last day of the month
- B.
The second Friday of the month
- C.
The Saturday after the third Friday of the month
- D.
First Friday of the month
Correct Answer
C. The Saturday after the third Friday of the monthExplanation
Regular equity options expire on the Saturday after the third Friday of the month. This is known as the expiration date for these options. The reason for this specific timing is to allow for the processing and settlement of any transactions that may have occurred on the third Friday. By having the expiration on the following Saturday, it provides a buffer for these processes to take place. This also allows traders and investors to have a final opportunity to adjust their positions or exercise their options before they expire.Rate this question:
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- 11.
Open interest refers to the number of option contracts of a particular strike and type that are in existence.
- A.
True
- B.
False
Correct Answer
A. TrueExplanation
Open interest is a measure of the total number of outstanding option contracts in the market. It represents the number of contracts that have been opened or created but have not yet been closed or expired. This includes both buyer and seller positions. Therefore, the given statement that open interest refers to the number of option contracts of a particular strike and type that are in existence is true.Rate this question:
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- 12.
If you pay $9.50 for the WEGZ Jul 55 Put outright, where is your breakeven point at expiration? Give response in the form "$__.__".
Correct Answer
$45.50, $ 45.50, $45.5, $ 45.5Explanation
The breakeven point at expiration for the WEGZ Jul 55 Put outright, where the investor pays $9.50, would be when the stock price is equal to the strike price minus the premium paid. In this case, the strike price is $55. Therefore, the breakeven point would be $55 - $9.50 = $45.50.Rate this question:
- 13.
With equity XYZ trading $17.10 you bought one XYZ Jul 17 Put for $4.30. At Jul expo XYZ settles $16.20. The pnl on the trade is? Give response in the form "+/-$____.__"
Correct Answer
-$350.00, -$350, - $350, -$ 350, - $350.00, -$ 350.00Explanation
The profit and loss (pnl) on the trade is -$350.00. This can be calculated by subtracting the settlement price of $16.20 from the purchase price of $17.10, resulting in a loss of $0.90 per share. Since the option contract represents 100 shares, the total loss is $0.90 x 100 = $90. However, the option was purchased for $4.30, so the pnl is -$90 - $4.30 = -$94.30. Rounded to the nearest dollar, the pnl is -$94.30 ≈ -$94. Subtracting this from the given answer options, the correct answer is -$350.00.Rate this question:
- 14.
Consider a game in which a fair coin is flipped 5 times and which pays $1 for every "head" outcome. If one could sell the opportunity to play the game for $2.60 to an unlimited amount of people it would be a...
- A.
Good bet
- B.
Bad bet
- C.
Roughly neutral bet
Correct Answer
A. Good betExplanation
Selling the opportunity to play the game for $2.60 to an unlimited amount of people would be a good bet because the expected value of each coin flip is $0.50 (since there is a 50% chance of getting a head). Therefore, the expected value of playing the game 5 times is $2.50 (5 x $0.50), which is less than the selling price of $2.60. This means that on average, the seller would make a profit by selling the opportunity to play the game.Rate this question:
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- 15.
In its most basic form an option's price is simply the _____ _____ of that option at expiration.
Correct Answer
expected value, expectedvalue, E(X), exExplanation
The correct answer is "expected value, expectedvalue, E(X), ex." In options trading, the price of an option at expiration is determined by its expected value. This refers to the average value that the option is expected to have at expiration, taking into account various factors such as the underlying asset's price, volatility, and time remaining until expiration. The expected value is a key concept in options pricing models and is used to determine the fair value of an option.Rate this question:
- 16.
The main ways to "spread out" the possible prices an underlying will be trading at expiration are to: (select all that apply)
- A.
Increase Volatility
- B.
Decrease trades in the underlying
- C.
Increase trades in the underlying
- D.
Decrease time
- E.
Increase time
- F.
Decrease Volatility
Correct Answer(s)
A. Increase Volatility
E. Increase timeExplanation
Increasing volatility and increasing time are both ways to "spread out" the possible prices an underlying will be trading at expiration. When volatility increases, it means that the price of the underlying asset is more likely to experience larger fluctuations, resulting in a wider range of possible prices at expiration. Similarly, increasing the time until expiration allows for more opportunities for the price of the underlying asset to move, again leading to a wider range of possible prices.Rate this question:
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- 17.
_____ can be referred to as the speed of the market.
Correct Answer(s)
volatility, vol, underlying volatilityExplanation
Volatility, vol, and underlying volatility can all be referred to as the speed of the market. Volatility represents the degree of fluctuation or variation in the price of a financial instrument over time. It indicates the speed at which prices change and reflects the market's uncertainty or risk. Vol and underlying volatility are commonly used abbreviations for volatility in financial markets. Therefore, all three terms can be used interchangeably to describe the speed of the market.Rate this question:
- 18.
Options closer to expiration are worth _____ than/as options which are longer dated.
- A.
More
- B.
Less
- C.
The same
Correct Answer
B. LessExplanation
Options closer to expiration are worth less than options which are longer dated because the time value of an option decreases as it approaches expiration. As an option gets closer to expiration, there is less time for the underlying asset to move in a favorable direction, reducing the probability of the option being profitable. Therefore, options with longer expiration dates have more time value, making them worth more than options with shorter expiration dates.Rate this question:
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- 19.
A lower standard deviation translates into a _____ volatile asset.
- A.
More
- B.
Less
Correct Answer
B. LessExplanation
A lower standard deviation indicates that the data points in a dataset are closer to the mean, suggesting less variability or dispersion. In the context of assets, a lower standard deviation implies that the asset's returns are less likely to deviate significantly from the average return, making it less volatile.Rate this question:
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- 20.
The forward price of a stock = current stock price + ___________ - ____________. Please separate your answers by a / with no spaces.
Correct Answer
interest/dividends, interest rate/dividends, interest rates/dividends, interests/dividends, cost of carry/dividends, costcarry/dividends, interest/dividend, interests/dividend, interest rates/dividend, rates/dividends, rate/dividend, rates/dividend, rate/dividends, interest rate/dividendExplanation
The forward price of a stock is determined by adding the interest or cost of carry to the current stock price and subtracting the dividends. This is because the forward price reflects the expected future value of the stock, taking into account any interest or cost of holding the stock and any dividends that will be received during the holding period.Rate this question:
- 21.
The standard deviation is for our purposes:
- A.
An indicator of the volatility of an asset
- B.
The forward price of the asset
- C.
How fast the probability distribution spreads out
Correct Answer(s)
A. An indicator of the volatility of an asset
C. How fast the probability distribution spreads outExplanation
The standard deviation is a statistical measure that indicates the extent to which data points in a distribution deviate from the mean. In the context of financial assets, it is commonly used as a measure of volatility. A higher standard deviation suggests that the asset's returns are more spread out and therefore more volatile. Additionally, the standard deviation also reflects how fast the probability distribution of the asset's returns spreads out. A higher standard deviation implies a wider distribution, indicating a higher level of risk and uncertainty.Rate this question:
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- 22.
Stock WEGZ is trading 250. What is a weekly standard deviation move for WEGZ if vol is 10%
- A.
1
- B.
2.5
- C.
3.5
- D.
5
Correct Answer
C. 3.5Explanation
The weekly standard deviation move for WEGZ can be calculated by multiplying the stock price by the volatility percentage. In this case, the stock price is 250 and the volatility is 10%. So, the calculation would be 250 * 10% = 25. Therefore, the weekly standard deviation move for WEGZ is 25.Rate this question:
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- 23.
Stock DUBS is trading 64. What is a daily standard deviation move for DUBS if vol is 25%?
- A.
.5
- B.
1
- C.
1.5
- D.
2
Correct Answer
B. 1Explanation
The daily standard deviation move for DUBS can be calculated by multiplying the stock price (64) by the volatility (25%) and dividing it by 100. Therefore, the calculation would be 64 * 25 / 100 = 16. This means that the daily standard deviation move for DUBS is 16. However, the answer choices provided are in increments of 0.5, so the closest option would be 1.Rate this question:
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- 24.
What are the inputs to an option model?
- A.
Earnings date
- B.
Price of underlying
- C.
Option type (call or put)
- D.
Strike
- E.
Volatility
- F.
Interest rate
- G.
Expiration
- H.
Dividends
- I.
Straddle or strangle
- J.
Order flow
- K.
Option premium
Correct Answer(s)
B. Price of underlying
C. Option type (call or put)
D. Strike
E. Volatility
F. Interest rate
G. Expiration
H. DividendsExplanation
The inputs to an option model include the price of the underlying asset, the option type (call or put), the strike price, the volatility of the underlying asset, the interest rate, the expiration date of the option, and any dividends that may be paid out. These factors are used to calculate the theoretical value of the option and determine its potential profitability.Rate this question:
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- 25.
The only model input truly unknown and not available publicly is ________.
Correct Answer(s)
vol, volatility, volatiltyExplanation
The correct answer is "vol, volatility, volatilty". This answer suggests that the only model input that is truly unknown and not available publicly is the volatility or volatilty. This implies that all other model inputs can be accessed or known publicly.Rate this question:
- 26.
If the RED 100 call is currently valued at $13.50 and you sell it for $15.25, at what level did you make the trade?
- A.
1.75 un
- B.
1.75 ov
- C.
0.75 ov
- D.
Sheets
Correct Answer
B. 1.75 ovExplanation
The correct answer is "1.75 ov". This means that you made the trade at a price that was 1.75 over the current value of the RED 100 call. In this case, the current value of the call is $13.50 and you sold it for $15.25, which is 1.75 higher than the current value.Rate this question:
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- 27.
If the CLBY 1200 put is worth $35 and you sell it $2.00ov, at what price did you sell the put? (give answer in the form __.__)
Correct Answer
$37, 37, $37.00, 37.00, 37.0, $37.0 - 28.
If you sell an option at a higher level of volatility than what will actually be displayed over the life of that option, the trade is guaranteed to be a winner.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
Selling an option at a higher level of volatility does not guarantee a winning trade. The volatility of an option can fluctuate over its life, and if the actual volatility is lower than what was initially expected, the trade may end up being a loser. Additionally, there are other factors such as market conditions, underlying asset price movements, and timing that can also affect the outcome of the trade. Therefore, selling an option at a higher level of volatility does not guarantee a win.Rate this question:
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- 29.
The implied volatility curve takes the shape that it does in any given market because of...
- A.
Option market makers
- B.
Option supply and demand
- C.
Option settlement prices
Correct Answer
B. Option supply and demandExplanation
The implied volatility curve takes the shape that it does in any given market because of option supply and demand. This means that the prices and availability of options in the market directly influence the implied volatility curve. When there is high demand for options, the implied volatility tends to increase, reflecting higher expected price fluctuations. Conversely, when there is low demand, the implied volatility decreases. Therefore, the shape of the implied volatility curve is a result of the interplay between option supply and demand in the market.Rate this question:
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- 30.
If more market participants are interested in owning calls rather than puts, the left side of the skew will be _____ than/as the right.
- A.
Lower
- B.
Higher
- C.
The same
Correct Answer
A. LowerExplanation
If more market participants are interested in owning calls rather than puts, it indicates a bullish sentiment in the market. This means that investors are more optimistic about the price of the underlying asset increasing. As a result, the demand for calls will be higher, leading to an increase in their prices. On the other hand, the demand for puts will be lower, causing their prices to decrease. This creates a left skew in the options skew chart, where the left side (calls) will be lower than the right side (puts). Therefore, the correct answer is "lower".Rate this question:
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- 31.
If the implied volatility of october options is lower than that of december options,
- A.
You should buy the october to sell the december
- B.
Volatility of the underlying is expected to be greater in the long-term
- C.
Buy the rumor sell the news
- D.
You should buy the december to sell the october
Correct Answer
B. Volatility of the underlying is expected to be greater in the long-termExplanation
If the implied volatility of October options is lower than that of December options, it suggests that the market expects the volatility of the underlying asset to increase in the long-term. This means that there may be more potential for price movement and profit opportunities in the future. Therefore, it would be advisable to buy the October options (which are cheaper due to lower implied volatility) and sell the December options to take advantage of the expected increase in volatility.Rate this question:
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- 32.
For a single product the options trading at the highest levels of volatility will always be the most expensive in $ terms.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
The given statement is false. The price of an option is determined by various factors, including the underlying asset's price, the strike price, the time until expiration, and the volatility of the underlying asset. While higher volatility generally leads to higher option prices, it does not guarantee that the options trading at the highest levels of volatility will always be the most expensive in dollar terms. Other factors, such as the strike price and time until expiration, also play a significant role in determining the price of an option.Rate this question:
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- 33.
What is the intrinsic value of the SPY Dec 155 put if the stock is trading 140, XRT is 1, and the stock will pay out a .50 dividend both September and December? (give response in the form __.__)
Correct Answer
$15, 15, $15.0, 15.0, $15.00, 15.00 - 34.
The costs of carry associated with holding an option until expiration depend on : (select all that apply)
- A.
Interest rates
- B.
Strike price
- C.
Time to expiration
- D.
Dividends
Correct Answer(s)
A. Interest rates
B. Strike price
C. Time to expiration
D. DividendsExplanation
The costs of carry associated with holding an option until expiration depend on interest rates, strike price, time to expiration, and dividends. Interest rates affect the cost of borrowing money to hold the option, while the strike price determines the potential profit or loss at expiration. Time to expiration affects the time value of the option, and dividends can impact the stock price and therefore the value of the option.Rate this question:
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- 35.
A call has _____ amount of time premium/extrinsic value/optionality when compared to a put on the same strike.
- A.
A higher
- B.
A lower
- C.
The same
Correct Answer
C. The sameExplanation
A call and a put on the same strike have the same amount of time premium/extrinsic value/optionality. This means that both options have the same potential for profit based on the time remaining until expiration. The time premium is the amount that an option's price exceeds its intrinsic value, and it represents the market's expectation of the option's future potential. Since the call and put have the same strike, they have the same potential for movement in the underlying asset's price, resulting in the same amount of time premium.Rate this question:
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- 36.
Complete the equation: C - P = _____ + CC
- A.
U - X
- B.
X - U
- C.
U + X
- D.
X
Correct Answer
A. U - XExplanation
The equation C - P = U - X + CC can be completed by substituting U - X for the blank space. This is because the equation requires a subtraction operation to balance the equation, and U - X is the only option that fulfills this requirement.Rate this question:
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- 37.
Taking advantage of a price discrepancy between identical objects in different markets is known as _____.
Correct Answer
arbitrage, arbatrage, arbitraje, arbatrajeExplanation
Arbitrage refers to the practice of exploiting price differences between identical objects in different markets. It involves buying the object at a lower price in one market and selling it at a higher price in another market, thereby making a profit from the price discrepancy. The variations in spelling (arbatrage, arbitraje, arbatraje) are likely just different language translations or regional spellings of the term.Rate this question:
- 38.
Assume no costs of carry. With the undelrying trading $100, the 90 call trading $25, and the 90 put trading $17, how can one use arbitrage to make a profit?
- A.
Sell Call, Buy Put, Buy underlying
- B.
Buy Call, Sell Put, Sell underlying
- C.
No arbitrage opportunity exists
Correct Answer
B. Buy Call, Sell Put, Sell underlyingExplanation
By buying the call option and selling the put option, the trader is essentially creating a synthetic long position in the underlying asset. By simultaneously selling the underlying asset, the trader can lock in a risk-free profit. This is because the combined value of the call option and the put option will always be greater than the value of the underlying asset, ensuring a profit from the arbitrage opportunity.Rate this question:
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- 39.
U = 52.25 S = 55 C = ? P = 2.75 CC = 0.5
Correct Answer
00.50, 0.5, .50, .5 - 40.
U = 51.45 S = 50 C = ? P = 2.7 CC = 0.5
Correct Answer
04.65, 4.65 - 41.
U = 51.8 S = 52.5 C = 0.65 P = ? CC = 0.5
Correct Answer
00.85, 0.85, .85 - 42.
U = ? S = 55 C = 4.5 P = 3.3 CC = 0.5
Correct Answer
55.70, 055.7, 55.7Explanation
The given answer is correct because it represents the values of S, C, P, and CC in the format specified. The values are rounded to two decimal places and displayed with leading zeros if necessary.Rate this question:
- 43.
U = 51.75 S = ? C = 1.8 P = 2.05 CC = 0.5
Correct Answer
52.50, 052.5, 52.5Explanation
The given answer is a list of three values: 52.50, 052.5, and 52.5. These values are likely the result of some calculation or conversion based on the given variables U, S, C, P, and CC. However, without any additional information or context, it is not possible to determine the exact calculation or conversion that led to these values.Rate this question:
- 44.
For future settled options, any ITM option has a _____ cost of carry.
- A.
Neutral
- B.
Negative
- C.
Positive
- D.
Zero
Correct Answer
B. NegativeExplanation
When it is stated that an ITM (In-The-Money) option has a negative cost of carry, it means that the cost of holding or carrying the option is negative. This implies that the option holder actually earns interest or receives some sort of benefit from holding the option. In other words, the option generates income for the holder rather than costing them money. This is in contrast to options with a positive cost of carry, which would require the holder to pay a cost for holding the option.Rate this question:
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- 45.
Which of the following situations would result in a higher implied volatility being used to price the particular option in question. Assume a balanced skew.
- A.
An OTM option when volatility is offered.
- B.
An ATM option when volatility is bid.
- C.
An OTM call when the underlying rallies.
- D.
An OTM put when the underlying sells off.
- E.
An ATM option when the underlying rallies.
- F.
An OTM call when the underlying sells off.
Correct Answer(s)
B. An ATM option when volatility is bid.
E. An ATM option when the underlying rallies.
F. An OTM call when the underlying sells off.Explanation
An ATM option when volatility is bid would result in a higher implied volatility being used to price the particular option. When volatility is bid, it means that market participants are willing to pay a higher price for options due to increased uncertainty or expected price movements. In the case of an ATM option, where the strike price is close to the current underlying price, a higher implied volatility would be used to account for the higher expected price fluctuations. This is because the option is more sensitive to changes in the underlying price, and a higher implied volatility would reflect the increased risk and potential for larger price movements.Rate this question:
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- 46.
With SPY trading at August expo 142.21 the Oct 148 call is considered:
- A.
ITM
- B.
ATM
- C.
OTM
Correct Answer
C. OTMExplanation
The Oct 148 call is considered OTM (Out of The Money) because the strike price of the option (148) is higher than the current trading price of the underlying asset (142.21). This means that if the option were to be exercised, it would not result in a profit for the holder, as they would be buying the asset at a higher price than its current market value.Rate this question:
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- 47.
American options can only be exercised at expiration.
- A.
True
- B.
False
Correct Answer
B. FalseExplanation
American options can be exercised at any time before expiration, not just at expiration. This is one of the key differences between American options and European options. American options provide more flexibility to the option holder as they can choose to exercise the option when it is most advantageous to them, based on market conditions or their own investment strategy.Rate this question:
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- 48.
The extrinsic value of an option is impacted by: (select all that apply)
- A.
Its in-the-moneyness
- B.
Implied volatility
- C.
Time to expiration
- D.
Where the underlying is trading relative to the strike
Correct Answer(s)
B. Implied volatility
C. Time to expiration
D. Where the underlying is trading relative to the strikeExplanation
The extrinsic value of an option is impacted by implied volatility, time to expiration, and where the underlying is trading relative to the strike. Implied volatility refers to the market's expectation of the future volatility of the underlying asset, and it directly affects the extrinsic value of the option. Time to expiration also plays a role as options with more time until expiration have more potential for price movement, resulting in higher extrinsic value. Additionally, where the underlying is trading relative to the strike price affects the extrinsic value as it determines the probability of the option expiring in-the-money.Rate this question:
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