Derivatives Quiz - Options and Stock Splits
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Questions and Answers

What is created when combining a short call option on a stock and a long position in the stock?

  • A protective collar
  • A covered call strategy
  • A long put option
  • A synthetic long position (correct)

    • When aiming to create a $1000 principal-protected note with a continuous interest rate of 5%, which combination is correct?

  • A one-year zero-coupon bond plus a one-year call option worth about $39
  • A one-year zero-coupon bond plus a one-year call option worth about $29
  • A one-year zero-coupon bond plus a one-year call option worth about $59
  • A one-year zero-coupon bond plus a one-year call option worth about $49 (correct)

    • What is the maximum net gain from a long butterfly spread involving 400 options with strike prices of $60, $65, and $70, valued at $11, $14, and $18 respectively?

  • $200
  • $400 (correct)
  • $300
  • $100

    • What is the maximum net loss when executing a long butterfly spread with the given options?

    <p>$100</p> Signup and view all the answers

    In a bull spread created with six-month call options costing $6 and $4, with strike prices of $35 and $40 respectively, what is the maximum gain?

    <p>$300</p> Signup and view all the answers

    What best describes a call option?

    <p>The right to buy an asset for a certain price</p> Signup and view all the answers

    What is true regarding long calls and short puts?

    <p>None of the above</p> Signup and view all the answers

    After a 2-for-1 stock split, what is the investor's position if they had options to sell 100 shares for $20?

    <p>Put options to sell 200 shares for $10</p> Signup and view all the answers

    What is the investor's position after a 25% stock dividend if they had options to sell 100 shares for $20?

    <p>Put options to sell 125 shares for $16</p> Signup and view all the answers

    What position does an investor have after receiving a $1 cash dividend on put options to sell 100 shares for $20?

    <p>The investor has put options to sell 100 shares for $20</p> Signup and view all the answers

    Which best describes a short position in an option?

    <p>A position where an option has been sold</p> Signup and view all the answers

    What distinguishes a warrant from an exchange-traded stock option?

    <p>The number of warrants is fixed while exchange-traded options vary</p> Signup and view all the answers

    What happens to the value of calls and puts when interest rates increase, assuming all else remains constant?

    <p>Calls increase in value while puts decrease in value</p> Signup and view all the answers

    What is the effect on the value of European options when the time to maturity increases, assuming all else remains constant?

    <p>European options are liable to increase or decrease in value</p> Signup and view all the answers

    Given a stock price of $30, a strike price of $25 for a European call option, and a risk-free rate of 4%, what is the lower bound for the option?

    <p>$5.98</p> Signup and view all the answers

    What is the correct lower bound for a European put option with a stock price of $50, strike price of $54, and a risk-free rate of 3%?

    <p>$0.86</p> Signup and view all the answers

    Which of the following statements is NOT true regarding options?

    <p>An American put option is always worth less than the present value of the strike price</p> Signup and view all the answers

    How is the intrinsic value of an option best described?

    <p>The value it would have if the owner were forced to exercise immediately</p> Signup and view all the answers

    Which of the following scenarios makes it more likely for an American put option to be exercised early?

    <p>The stock price volatility decreases</p> Signup and view all the answers

    What should be assumed about an American call option when considering early exercise?

    <p>It should never be exercised early</p> Signup and view all the answers

    What effect does a European put option have when the price is at $5.50?

    <p>It suggests a potential increase in the put price to $6.00</p> Signup and view all the answers

    What is a true statement regarding the relationship between a European call and put option given their respective prices?

    <p>Neither the call nor the put price shows any signs of mispricing</p> Signup and view all the answers

    Which scenario correctly explains the creation of a long position in a European put option?

    <p>Buying a call option and shorting the stock</p> Signup and view all the answers

    Which of these options can be utilized to form a box spread?

    <p>A bull spread combined with a bear spread</p> Signup and view all the answers

    Which combination accurately represents a bull spread?

    <p>Buy a low strike call and sell a high strike call</p> Signup and view all the answers

    What is the main characteristic of a straddle?

    <p>Consists of buying one call and one put with the same strike price</p> Signup and view all the answers

    How is a strip trading strategy defined?

    <p>Buying one call and two puts with the same strike price</p> Signup and view all the answers

    Which of the following correctly describes a bear spread?

    <p>Buying a high strike put and selling a low strike put</p> Signup and view all the answers

    What is an appropriate strategy to create a bull spread?

    <p>Buy a low strike put and sell a high strike put</p> Signup and view all the answers

    Which statement best describes a strap trading strategy?

    <p>Buying two calls and one put with the same strike price</p> Signup and view all the answers

    What correctly illustrates the nature of put-call parity?

    <p>It provides a framework for determining option price discrepancies</p> Signup and view all the answers

    What best defines a protective put?

    <p>A long put option along with a long position in the stock</p> Signup and view all the answers

    Which of the following can lead to a correct understanding of volatility in trading options?

    <p>Increased volatility usually leads to higher option prices</p> Signup and view all the answers

    Which component is necessary for implementing a covered call?

    <p>A long position in the stock with a short call option</p> Signup and view all the answers

    What strategy is used to profit from high volatility in the market without direction?

    <p>Strangle</p> Signup and view all the answers

    In which scenario would a trader use a diagonals spread?

    <p>When buying and selling calls at the same strike price but different maturities</p> Signup and view all the answers

    What is one reason an American call option should not be exercised early when no dividends are expected?

    <p>The time value of the option is lost.</p> Signup and view all the answers

    Which statement describes the put-call parity for a non-dividend-paying stock accurately?

    <p>The put price plus the stock price must equal the call price plus the present value of the strike price.</p> Signup and view all the answers

    When dividends are expected, how is the basic put-call parity formula modified?

    <p>By subtracting the present value of expected dividends from the strike price.</p> Signup and view all the answers

    What is the price of a one-year European put option on a non-dividend-paying stock with a strike price of $50, stock price of $51, and call price of $6?

    <p>$2.09</p> Signup and view all the answers

    Given a European call option price of $6 on a stock priced at $51 with a strike price of $50, what is the value of a European put option if a dividend of $1 is expected in six months?

    <p>$3.06</p> Signup and view all the answers

    How does the price of options react to an increase in volatility, assuming no change in stock price or interest rates?

    <p>Call prices tend to increase while put prices may or may not be affected.</p> Signup and view all the answers

    Why might an American call option on a stock be subjected to early exercise considerations?

    <p>There is a possibility of receiving a dividend after the option's expiration.</p> Signup and view all the answers

    Which of the following scenarios would likely NOT affect put-call parity?

    <p>A decrease in the market's overall volatility.</p> Signup and view all the answers

    Study Notes

    Multiple Choice Questions - Derivatives

    • Option Description: A call option is the right to buy an asset at a specific price, while a put option is the right to sell an asset at a specific price.

    • Call and Put Relationship: A short call is the same as a long put, and a long call is the same as a short put.

    • Stock Split & Options: A 2-for-1 stock split changes the number of shares affected by the option from 100 to 200 and the strike price from $20 to $10. A 25% stock dividend changes the position of the investor from 100 shares to 125 shares, and the strike price adjusts accordingly. A $1 cash dividend doesn't affect the position.

    • Short Position: A short position in an option means the option has been sold.

    • Warrants and Options: Warrants have a set number of shares whereas exchange traded options have a number that depends on market trading.

    • LEAPS (Long-term Equity Anticipation Securities): These options on stocks have longer expiry periods (time horizons) than regular stock options.

    • Stock Option Classes: All calls on a particular stock is an example of an Option Class. All calls with a specific strike price and duration is an example of an Option Series.

    • Margin Requirements: The buyer and seller of an option must post margins.

    • Long Option Position: A long position in an option is when an option is purchased.

    • CBOE Traded Options: CBOE trades weekly and monthly options, not binary or doom options.

    • Option Value Variation: When a stock price increases (with other variables remaining the same), call values increase, and put values decrease. When strike prices increase, put values increase, and call values decrease. When volatility increases, both call and put values increase. When dividends increase, put values increase, and call values decrease. When interest rates increase, call values increase and put values decrease. When time to maturity increases, option values may increase or decrease.

    • American vs European Options: American options can be exercised at any time, whereas European options can only be exercised at maturity.

    • Additional Concepts (from later questions):

      • Straddles: Straddles are created by buying a call and a put with the same strike price and expiration date.

      • Protective Puts: A protective put involves buying a put option on a stock plus a long position in the stock.

      • Covered Calls: Covered calls involve owning the underlying asset, such as a stock, and selling a call option on that stock.

      • Butterfly Spreads: Butterfly spreads use 3 option series with different strike prices, typically creating a net gain profit.

      • Calendar Spreads: Calendar spreads use calls or puts with identical strike prices.

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    Description

    Test your knowledge about derivatives with this quiz focused on options, stock splits, and related concepts. Understand call and put options, their relationships, and how stock adjustments affect option pricing. Perfect for finance students looking to solidify their understanding of these critical financial instruments.

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