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Exam 14: Options and Risk Management

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Question 31

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A share is trading at $50. You believe there is a 60% chance the price of the share will increase by 10% over the next three months. You believe there is a 30% chance the share will drop by 5% and you think there is only a 10% chance of a major drop in price of 20%. At-the-money 3-month puts are available at a cost of $650 per contract. What is the expected dollar profit for a writer of a naked put at the end of three months?

A) $300
B) $200
C) $475
D) $0

E) None of the above
F) A) and B)

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Question 32

Multiple Choice

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You write a put option on a share. The profit at contract maturity of the option position is ________ where X equals the option's strike price, ST is the share price at contract expiration and P0 is the original premium of the put option.

A) Max(P₀, X - S_T - P₀)
B) Min(-P₀, X - S_T - P₀)
C) Min(P₀, S_T - X + P₀)
D) Max(0, S_T - X - P₀)

E) A) and D)
F) B) and C)

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Question 33

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Investor A bought a call option and Investor B bought a put option. All else equal if the underlying share price volatility increases the value of Investor A's position will ________ and the value of Investor B's position will ________.

All else equal, call option values are ________ if the ________ is lower.

You purchase one IBM July 120 put contract for a premium of $3. You hold the option until the expiration date when IBM stock sells for $123 per share. You will realise a ________ on the investment.

At contract maturity the value of a call option is ________ where X equals the option's strike price and ST is the share price at contract expiration.

The writer of a put option ________.

In the Black-Scholes model if an option is not likely to be exercised both N(d1) and N(d2) will be close to ________. If the option is definitely likely to be exercised N(d1) and N(d2) will be close to ________.

The value of a listed put option on a share is lower when ________. I. the exercise price is higher II. the contract approaches maturity III. the share decreases in value IV. a share split occurs

What strategy could be considered insurance for an investment in a portfolio of shares?

You purchase one IBM March 120 put contract for a put premium of $10. The maximum profit that you could gain from this strategy is ________.

You buy one Hewlett Packard August 50 call contract and one Hewlett Packard August 50 put contract. The call premium is $1.25 and the put premium is $4.50. Your highest potential loss from this position is ________.

A high dividend payout will ________ the value of a call option and ________ the value of a put option.

The value of a call option increases with all of the following except ________.

In the Black-Scholes model as the share's price increases the values of N(d1) and N(d2) will ________ for a call and ________ for a put option.

The ________ is the share price minus exercise price, or the profit that could be attained by immediate exercise of an in-the-money call option.

Which one of the following will increase the value of a put option?

A writer of a call option will want the value of the underlying asset to ________ and a buyer of a put option will want the value of the underlying asset to ________.

You write one IBM July 120 call contract for a premium of $4. You hold the option until the expiration date when IBM stock sells for $121 per share. You will realise a ________ on the investment.

What combination of variables is likely to lead to the lowest time value?