Q&A Hero

Q: to construct a bear spread, the investor buys a call option and shorts the stock.

Q: bull and bear spreads require taking a long position in one option and a short position in another option with a different strike price.

Q: if investors believe that a stock's prices will fluctuate but they are not certain as to the direction, these investors may buy a straddle.

Q: an investor cannot buy and sell two different call options with the same expiration dates.

Q: the "collar strategy" is used to lock-in profits from an increase in the price of a stock.

Q: the protective call strategy is an illustration of a short position.

Q: an investor buys a straddle in anticipation of stable stock prices.

Q: writing both a put and a call at the same strike price and expiration date is an illustration of a straddle.

Q: if an individual sells a stock short, that investor is protected from a large increase in the price of the stock by selling a call option.

Q: the hedge ratio is one piece of information given by the black/scholes option valuation model.

Q: if the hedge ratio is 0.7, the number of call options necessary to offset a long position in a stock is 7.0.

Q: the hedge ratio indicates the number of call options that is necessary to offset price movements in the underlying stock.

Q: according to put-call parity, if a stock is overvalued (overpriced), the investor should sell the stock short, sell the put, buy the call, and buy the bond.

Q: put-call parity explains why a change in interest rates by the federal reserve affects stock and option prices.

Q: put-call parity suggests that the sum of the prices of a stock, a call and a put on that stock, and a debt instrument maturing at the expiration of the options must equal zero.

Q: the black/scholes option valuation model divides the option's strike price by the probability that the option will be exercised.

Q: according to the black/scholes option valuation model, the value of a call option rises as interest rates increase.

Q: according to the black/scholes option valuation model, the value of a call option rises as it approaches expiration.

Q: 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?

Q: answer the questions given the following information: price of a stock $52 strike price of a threemonth 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?

Q: because of the small cash outlay to buy an option, these securities are considered to be conservative investments.

Q: a warrant is an option issued by a corporation to buy its stock at a specified price within a specified time period.

Q: as the price of a stock rises, the time premium paid for an option to buy stock increases.

Q: the time premium paid for an option reduces the option's potential leverage.

Q: an option's intrinsic value exceeds the option's price.

Q: since options offer potential leverage, they tend to sell for a time premium.

Q: investors and speculators rarely have an opportunity to establish an arbitrage position.

Q: if the price of an option to buy stock were to sell for less than its strike price, an opportunity for arbitrage exists.

Q: because of arbitrage, an option should not sell for less than its intrinsic value.

Q: arbitrage determines the maximum price of an option.

Q: arbitrage is the act of simultaneously buying and selling in two markets to take advantage of price differentials.

Q: the strike price of an option is fixed.

Q: the price of an option is generally less than the option's intrinsic value.

Q: the intrinsic value of an option to buy stock (i.e., a call option) is the difference between the price of the stock and the per share exercise price of the option.

Q: the writer of a covered call cannot lose money if the price of the stock rises.

Q: a writer of a naked call option will lose money if the price of the stock declines.

Q: writing covered call options is more risky than writing naked call options

Q: calls tend to sell for a time premium that exceeds the stock's price.

Q: the intrinsic value of a call option is the strike price minus the stock's price.

Q: when a call option is exercised, new stock is issued.

Q: the cboe is a secondary market for put and call options.

Q: call options, unlike warrants, may be written by individuals.

Q: the time period to expiration for call options is usually for less than a year.

Q: calls are options to sell stock at a specified price within a specified time period.

Q: the maximum potential profit on a covered call is the time premium paid for the stock.

Q: a covered call is constructed by buying the stock and selling the call.

Q: holders of calls do not receive the cash dividends paid to the company's stockholders.

Q: in addition to put and call options on individual stocks, there are also options on the market as a whole (i.e., an index).

Q: an investor may reduce risk by simultaneously purchasing a stock and a put option.

Q: if the price of a stock rises, the writer of a put option profits.

Q: the intrinsic value of a put establishes the put's maximum price.

Q: the intrinsic value of a put is the price of the stock minus the put's strike price.

Q: the profits (gains) on option trading are exempt from federal income taxation.

Q: while individuals can write call options, they can only buy put options.

Q: the value of a put is inversely related to the value of the underlying stock.

Q: a put is an option to sell stock at a specified price within a specified time period.

Q: the writer of a call option does not receive any dividends paid by the firm.

Q: selling a covered call option is comparable to selling a stock short.

Q: the buyer of a call option wants the price of the stock to rise.

Q: the price of a call option is often more volatile than the price of the underlying stock.

Q: there is no limit to the potential loss from buying a call option

Q: if an investor anticipated that interest rates would rise, that individual should sell an option to buy treasury bonds

Q: a portfolio manager with a position in many stocks may hedge the portfolio by purchasing a stock index call option.

Q: in-the-money stock index options are not exercised.

Q: if an investor is bearish, he or she should not buya stock index call option.

Q: the intrinsic value of an option to buy stock rises as 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

Q: the intrinsic value of an option sets 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

Q: the intrinsic value of an option to buy stock is 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

Q: stock index options permit investors to establish a position in the market without having to select individual stocks.

Q: the most the individual who buys a put option can lose is the cost of the option.

Q: the most the investor who sells a naked stock index option can lose is the cost of the option.

Q: buying a stock index option reduces systematic risk.

Q: if the investor buys a stock index put, the individual will profit if the market rises.

Q: the time premium paid for an option to buy stock 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

Q: warrants and calls do not have a. an expiration date b. a specified exercise price c. the right to receive dividends d. a strike price

Q: warrants are issued by a. individuals b. firms c. governments d. investors

Q: options sell for a time premium over their intrinsic value because a. they earn dividends b. they are debt obligations c. they offer potential leverage d. they are long-term investments

Q: options to buy stock offer a. potential leverage b. potential income c. safety of principal e. liquidity

Q: because of arbitrage, the price of an option 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

Q: the price of a call depends on 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