Chapter 6

What is an uncovered call (naked call)?

A call option sold without owning the underlying stock; has unlimited risk.

What is a covered call?

A call option sold while owning the underlying stock; used to generate income.

What does it mean for an option to be in-the-money (ITM)?

An option that has intrinsic value: market price is above strike for calls, or below for puts.

What does it mean for an option to be out-of-the-money (OTM)?

An option that has no intrinsic value: market price below strike for calls, or above for puts.

What is time value in relation to options?

The portion of an option premium representing time left until expiration.

What is intrinsic value of an option?

The amount by which an option is in-the-money.

What is the role of the OCC (Options Clearing Corporation)?

Guarantees the performance of option contracts and acts as a clearinghouse.

What is a hedge in finance?

Taking an opposite or offsetting position to protect against risk.

What is a closing transaction in options trading?

Liquidating an existing options position (buying to close a short, selling to close a long).

What is meant by an option series?

Contracts with the same class, strike price, and expiration.

What is an option adjustment?

Changes to contracts due to splits or dividends, keeping contract value the same.

What are foreign currency options?

Options based on foreign currency value vs. USD; cannot buy/sell USD options.

Which of the following is a feature of a covered call? A) High risk, high reward

• B) Unlimited profit potential

• C) Income with limited upside

• D) Used to hedge a short sale

Covered calls are used for income but cap gains if exercised.

Which organization guarantees the performance of options?

• A) FINRA

• B) CBOE

• C) OCC

• D) SEC

C — OCC is the clearinghouse and guarantor for options.

When would a VIX put expire worthless?

• A) When the VIX is above the strike price

• B) When the VIX is below the strike price

• C) Always

• D) Never

A — A VIX put is OTM if the index is above the strike price.

Which of the following represents an options closing transaction?

• A) Writing a new call

• B) Buying to close an existing short call

• C) Buying to open a long call

• D) Exercising a put

Buying to close ends a short call position.

Which best describes a long call option that is out-of-the-money?

• A) Strike > market

• B) Strike < market

• C) Premium = intrinsic value

• D) Exercise is guaranteed

A — For calls, it’s OTM when strike is higher than market.

What is the breakeven for writing ABC Mar 76 calls at 2.50?

• A) $78.50

• B) $76.00

• C) $73.50

• D) $74.00

A — Strike + premium = breakeven.

Investor writes 2 XYZ April 70 calls for a $3 premium. If the market price at expiration is $75, what is the total gain or loss?

• A) $400 loss

• B) $400 gain

• C) $200 loss

• D) $1,000 gain

A — The options are exercised. Loss = ($75 - $70 - $3) × 200 = $400 loss.

Investor sells 1 ABC Oct 50 put for $4. What is the breakeven, and what happens if the market price falls to $45 at expiration? A) Breakeven = $46; $100 gain

• B) Breakeven = $46; $100 loss

• C) Breakeven = $46; $1000 loss

• D) Breakeven = $50; no exercise

B — Breakeven = $50 - $4 = $46. At $45, investor buys stock at $50, sells at $45 = $100 loss.

Investor writes 1 XYZ Jan 90 call at 2. The stock rises to $97 at expiration. What happens?

• A) Option expires unexercised

• B) Breakeven = $92; $500 loss

• C) Contract is exercised; $500 loss

• D) Contract is exercised; $300 gain

C — Breakeven = $92; Loss = ($97 - $90 - $2) × 100 = $500 loss.

An investor sells 1 put option on ABC at a strike of $40 for $2 premium. If ABC closes at $38, what’s the result?

• A) Gain of $200

• B) Loss of $100

• C) Gain of $100

• D) Loss of $200

• C — Breakeven = $38. No loss since market = breakeven. Investor keeps $2 premium.

A portfolio manager wants to hedge his long equity positions and increase the portfolio's income. Which of the following strategies is appropriate? Long index call, short index call, long index put, short index put

short index call

Q: When does the premium change hands between the buyer and seller of an option?

A. When the trade is settled B. When the option goes in-the-money C. At expirationD. At expiration, but only if the option is exercised

✅ Explanation: The correct answer is A. The seller earns the premium and receives the cash when the option trade is settled. Settlement occurs one business day after the trade date.

Q: Three put options trade at a price of $3 each. They have a strike price of $25 on a stock currently selling for $27. How much premium changes hands and who receives it?

. The writer pays the buyer $900

B. The buyer pays the writer $900

C. The writer pays the buyer $1,500

D. The buyer pays the writer $1,500

✅ Explanation: The correct answer is B. The option buyer pays the premium to the writer. Premium = 3 contracts × 100 shares × $3 = $900.

Q: When can the buyer of an American-style option exercise it?

A. At any time before contract expiration date’

B. At any time within 10 business days before contract expiration date

C. At any time up to two business days after contract expiration date

D. Only on the contract expiration date

✅ Explanation: The correct answer is A. American-style options can be exercised at any time before the expiration date.

Q: On which day of an expiration month does a listed options contract expire?

A. The second Tuesday

B. The first Wednesday

C. The third Friday

D. The last business day of the month

✅ Explanation: The correct answer is C. Listed options contracts expire on the third Friday of the expiration month.

Q: If you think a company is greatly overvalued and believe its stock price will fall, which options strategy would allow you to earn a big profit if you are correct?

A. Sell calls

B. Sell puts

C. Buy calls

D. Buy puts

✅ Explanation: The correct answer is D. Buying puts gives the investor the right to sell stock at a set price and profit when the stock's market price falls.

Q: What is a naked call write?

A. Buying a call without owning the underlying stock

B. Selling a call without owning the underlying stock

C. Buying a deep-out-of-the-money call and hoping it will become profitable

D. Buying a deep-in-the-money call and then losing your shirt

✅ Explanation: The correct answer is B. A naked call write involves selling a call without owning the underlying stock, exposing the seller to unlimited risk if the stock rises.

Q: Nathan buys 20 call options at a premium of $4.50 and a strike price of $95. At the time of the trade, they are out-of-the-money by $2.25. What is his breakeven stock price on the position?

A. $90.50B. $92.75C. $97.25D. $99.50

✅ Explanation: The correct answer is D. Breakeven for a call buyer is strike price + premium = $95 + $4.50 = $99.50.

Q: What options strategy can be a viable way to hedge the downside risk of a short sale of the underlying stock?

A. Buy puts

B. Buy calls

C. Sell puts

D. Sell covered calls

✅ Explanation: The correct answer is B. Buying calls gives the short seller the right to buy stock at the strike price, limiting potential losses if the stock rises.

Q: Joan has bought puts with a strike price of $40 and a premium of $2 per share. The underlying stock is at $47. How could her current options position be accurately described?

A. The puts are out-of-the-money by $7 per share

B. The puts are out-of-the-money by $9 per share

C. The puts are in-the-money by $5 per share

D. The puts are in-the-money by $7 per share

✅ Explanation: The correct answer is A. Puts are out-of-the-money when the stock price is above the strike price. $47 - $40 = $7.

Q: What are the components of a protective put position?

A. Own stock, buy puts

B. Be short stock, sell puts

C. Own stock, sell puts

D. Be short stock, buy puts

✅ Explanation: The correct answer is A. A protective put involves owning the stock and buying puts to limit downside risk.

Q: Carl owns Apple stock and believes it will do well. However, he is worried that it could be dragged lower by a downturn in the stock market as a whole. How can he continue to own Apple, and participate in any upside, without being exposed to a general stock market downturn?

A. Sell Apple calls

B. Buy Apple puts

C. Buy S&P 500 Index calls

D. Buy S&P 500 Index puts

✅ Explanation: The correct answer is D. Buying index puts allows him to hedge against general market risk while still holding Apple stock.

Q: Assuming it’s January 2020 and all other factors being equal, which option is likely to have the greatest premium?

. XYZ March call

B. XYZ June call

C. XYZ August call

D. XYZ October call

✅ Explanation: The correct answer is D. Longer-dated options have more time value, so the October call would carry the highest premium.

Q: Herbert buys 30 call options on General Foods stock. Who is the legal counterparty on his contract?

A. A call seller

B. A put buyer

C. General Foods

D. The Options Clearing Corporation

✅ Explanation: The correct answer is D. The OCC is the counterparty to all listed options contracts, ensuring contract performance.

Q: Jenny bought October put options with a strike price of $30, and she paid a premium of $2.50. She wants to close the position now, with the stock at $27 and the option worth $4.50. What will her closing transaction and net profit per contract be?

A. Buy calls; $250 net profit per contract

B. Sell puts; $200 net profit per contract

C. Sell calls; $450 net profit per contract

D. Do nothing; no profit or loss

✅ Explanation: The correct answer is B. She sells the puts for $4.50 after buying at $2.50, yielding a $2.00 profit per share or $200 per contract.

Q: What is the settlement time frame for listed options contracts?

A. The trade date

B. T + 1

C. T + 2

D. Settlement dates can vary by contract

✅ Explanation: The correct answer is B. Options settle on the business day following the trade date (T + 1).

Q: Anthony owns in-the-money call options, and the underlying stock has already declared a quarterly dividend. The record date for the dividend is in two weeks: Friday, June 14. By what date must he exercise his options to be sure of receiving the dividend on the stock delivered?

A. June 9

B. June 11

C. June 13

D. He will not receive the dividend because he was not the stockholder of record when the dividend was declared

✅ Explanation: The correct answer is C. He must exercise the option and be the stockholder of record by the day before the ex-dividend date. With T + 1 settlement, he must exercise on June 13.

All of the following investors would benefit from the purchase of an S&P 500 put EXCEPT

An investor who is highly bearish on the market overall and wants to profit from a decline in its level

An investor who wants diversify a portfolio with downside exposure of the S&P 500, but does not wish to establish short positions in shares of multiple component issues

An investor who wants to take advantage of the leverage that options can provide with a limited dollar risk

An investor who wishes to generate portfolio income and believes that the market is likely to remain flat

An investor who wishes to generate portfolio income and believes that the market is likely to remain flat —— An Index put allows the investor to profit from a downward move in the level of the market as measured by S&P 500 index, while committing less capital compared to the margin requirements needed for the short sale of a number of component issues. A long put holder is not subject to the unlimited upside risk that applies to investors with short stock positions. The maximum loss to the investor is the premium paid.

All of the following statements regarding premiums for index options are true EXCEPT

Premiums for index options are quoted in points and decimal amounts like equity options

An index premium point is ordinarily equal to $100

The premium of an index put will generally increase as the level of the underlying index increases

The premium of an index option is comprised of intrinsic value and time value

The premium of an index put will generally increase as the level of the underlying index increases

Index options premiums are similar to equity option premiums. They are quoted in points and decimal amounts, and multiplier is ordinarily equal to $100, and premium components are intrinsic value (the in-the-money amount) and time value. The premium of a put on either an index option or an equity option increases as the underlying decreases in value.