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12 Cards in this Set

  • Front
  • Back

If a customer does not anticipate that a stock's price will change and he wants to take an option position, he would MOST likely:

A) buy a straddle

B) write a straddle

C) buy a call

D) buy a put

Answer: B

The customer earns combined premiums when selling a straddle (call + put w/same terms). He hopes the market price will not move, both positions will expire unexercised and he will keep the premiums. This position has unlimited loss potential should the underlying stock rise (because of the short call).

Which of the following are spreads?

1. Long 1 FLB May 40 call; short 1 FLB May 50 call

2. Long 1 FLB May 40 call; long 1 FLB May 50 call

3. Long 1 FLB Aug 40 call; short 1 FLB May 40 call

4. Long 1 FLB Aug 40 call; short 1 FLB Aug 50 put

Answer: 1 & 3

Each includes one long and one short option of the same type with different strike prices or different expiration dates.

A customer sells an FLB Mar 35 call. To establish a straddle, she would:

A) buy an FLB Mar 35 put

B) buy an FLB Mar 40 call

C) sell an FLB Mar 35 put

D) sell an FLB Mar 40 call

Answer: C

Straddles involve options of different types, but both options must be of the same series. A series has the same strike price, expiration date and underlying security.

A RR executes the following trades for an options account:

Buy 1 FLB Apr 40 call at 9

Sell 1 FLB Apr 45 call at 4

Are these suitable trades?

A) No, because the customer cannot make a profit on these trades.

B) It depends on the customer's investment objectives.

C) It is impossible to tell.

D) Yes, because the trades will result in a small profit.

Answer: A

These trades are not suitable because the customer will not make a profit. In any price spread, the net debit represents max loss; in this case, the net debit is 5 points, or $500. Max loss added to max gain will always = difference between the strike prices. In this example, the difference between the strike price is 5 points, therefore max gain is 0.

An active options trader establishes the following position:

Long 10 ALF Apr 40 calls at 6

Short 10 ALF Apr 50 calls at 2

What is the breakeven point?

A) 4

B) 40

C) 46

D) 44

Answer: D

The breakeven on a call spread is determined by adding the difference in premiums (6-2=4) to the lower strike price. In this case, the net debit = 4 points; therefore, 4+40=44.

If your client writes a combination of a DWQ 45 call and a DWQ 50 put and the premiums total $650, he breaks even when the price of the underlying stock is:

1. $43.50

2. $50.50

3. $51.50

4. $56.50

Answer: 1 & 3

Combinations and straddles have 2 breakeven points. To calculate, add the combined premiums to the call strike price and subtract the combined premiums from the put strike price.

($650 + $4500 = $5150/51.50)

($5000 - $650 = $4350/43.50)

If a customer buys 5 ABC Sep 50 calls at 5 and 5 ABC Sep 50 puts at 3, this position is called a:

A) ratio write

B) hedge

C) straddle

D) spread

Answer: C

A straddle is an option strategy in which the investor holds a position in both a call and a put with the same strike price, expiration and underlying security.

If an investor buys a Jan 30 XYZ call for 4 and sells a Jan 35 call for 2, to become profitable, the spread between the prices of the two options must:

A) remain the same

B) fluctuate

C) widen

D) narrow

Answer: C

This is a debit spread (long premium > short premium). These are profitable when the difference between the premiums widens. A debit spread has a closed credit (buy), so to be profitable, the credit must be larger than the opening debt (sell)

If a customer buys 1 XYZ Nov 70 put and sells 1 XYZ Nov 60 put when XYZ is selling for 65, this position is a:

A) combination

B) straddle

C) bear spread

D) bull spread

Answer: C (bear spread)

This put spread is established as a debit because the customer pays more for the 70 put than she receives for the 60 put. A debit spread is a net buy, while a credit spread is a net sale. Therefore, a debit put spread is like buying a put, which is bearish.

All of the following are credit spreads EXCEPT:

A) write 1 ABC Nov 35 put; buy 1 ABC Nov 30 put
B) buy 1 ABC Apr 40 call; write 1 ABC Apr 30 call
C) buy 1 ABC Jan 50 put; write 1 ABC Jan 60 put
D) buy 1 ABC Jul 50 call; write 1 ABC Jul 60 call

Answer: D

The lower the strike price is, the more expensive the call premium for the option will be. The investor has purchased the option with the lower strike price, so this is a debit spread. With puts, the higher the strike price is, the more expensive the option premium will be.

In which of the following strategies would the investor want the spread to widen?

1. Buy 1 RST May 30 put; write 1 RST May 25 put

2. Write 1 RST Apr 45 put; buy 1 RST Apr 55 put

3. Buy 1 RST Nov 65 put; write 1 RST Nov 75 put

4. Buy 1 RST Jan 40 call; write 1 RST Jan 30 call

Answer: 1 & 2

An investor wants a debit spread to widen. As the difference between premiums increases, so does potential profit because the investor may sell the option with the higher premium and buy back the option with the lower premium. With credit spreads, investors profit if the spread between the premiums narrows.

Which of the following statements regarding straddles are TRUE?

1. An investor who expects no change in a stock's price and wishes to generate income sells a straddle.

2. An investor who expects no change in a stock's price buys a straddle.

3. An investor who expects a substantial decline in a stock's price sells a straddle.

4. An investor who expects substantial fluctuations in a stock's price and is unsure as to direction buys a straddle.

Answer: 1 & 4

A long straddle is the purchase of a put & a call on the same stock when both options have the same terms. The long call is profitable if the market rises, while the long put is profitable if the market falls. An investor purchases a straddle if sharp market movement is expected but the direction is uncertain. A short straddle is the sale of a put and a call on the same stock with both options having the same terms. If the market value remains stable, the options expire and the seller keeps the premium, thereby generating income.