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1. A customer with a margin account believes the market is going to head lower and wants trade stock and options. Because of the bear market, put premiums have become very expensive and call premiums have declined. Stock XYZ is currently trading at $50, and the Aug 50 Calls are trading at $5 and Aug 50 Puts are trading at $15. In order to place this trade with the smallest capital commitment, what should the trader do?
Buy long 100 shares of XYZ at $50 and buy 1 XYZ Aug 50 Call
Buy long 100 shares of XYZ at $50 and sell 1 XYZ Aug 50 Call
Sell short 100 shares of XYZ at $50 and sell 1 XYZ Aug 50 Put
Sell short 100 shares of XYZ at $50 and buy 1 XYZ Aug 50 Call

Answer: C

This trade is the best way to speculate on the market decline with the smallest capital commitment.

If the trader buys the put, they must pay a premium of $1500. And if the trader shorts the stock at $50, a 50% margin requirement is needed. This means $2500 will have to be deposited into the account to trade the stock short.

When a trader places a covered put trade, the $2500 on the short stock will be offset with premium collected from the short put of $1500. The net deposit for this position will be $1000. This is the smallest capital commitment for the trader.

2. A customer buys 200 shares of GE at 10 and sells 2 GE Jun 8 calls at $5. What is the maximum potential gain?
500
600
700
800

Answer: B

Stock delivered at $8 for exercised calls on stock that cost $10. This is a loss of $2 per share. $5 was collected in premiums from sale of Jun 8 calls, the net gain, if exercised, is $3.00, or $300 per contract x 2 contracts = $600

3. What can be used to efficiently hedge a broadly diversified stock portfolio?
Foreign exchange
Bonds
Precious Metals
SP500 Options
Answer : D

4. What is the best option position to hedge a short stock position?
Long Puts
Short Puts
Long Calls
Short Calls

5. A trader buys 100 shares of XYZ at $50 and buys 1 XYZ Jan 50 Put at $5. This position results in a profit when the price of ABC:
Goes above 30
Goes below 50
Goes above 55
Goes above below 20

Answer B

The trader paid $50 for the stock and $5 for the put, a total of $55 paid. If the stock moves to $55, that is the breakeven on the position. If the stock moves below $55, the trader can lose money because of the premium paid on the puts. The max loss is $5 because the trader can exercise the $50 put to limit losses on stock purchased at $55.

6. Intrinsic value is…
The difference between the strike price and market price of the underlying stock
The difference between the option price and the market price of the underlying stock
The strike price plus underlying stock price divided by 2.
The strike price minus market price plus premium paid

Answer: A

7. A trader owns 100 shares of XYZ stock and 1 XYZ put option. The customer wishes to sell stock by exercising the put but wants to keep the cash dividend. In order to receive the dividend, the trader cannot exercise the option:
Before the ex date
After the ex date
After the dividends are paid
Before the announcement date

Answer : A

8. In November a customer buys 1 XYZ Jan 100 Call @ $10 when the market price is $101. If the customer closes out the position prior to expiration by selling the call at $8, the gain or loss is?
$100
$200
$300
$400

Answer : B

9. A customer sells short 100 shares of ABC at $50 and purchases 1 ABC Jan 45 Call at $2.50. ABC drops to $40 and the customer closes the options contract at $1.50 and buys the stock at the current price. The customer has a profit or loss of…
500
700
900
1000

Answer : C

10. A trader sells 1 AAPL Jan 250 Call at $10 when the market price of AAPL is $240. What is the maximum profit potential of this position?
1000
1500
500
250

Answer : A

The maximum profit potential when selling a naked call option is the premium received. This occurs when the market drops and the call expires out-of-the-money.

11. A trader buys 100 shares of AAPL stock at $250 and buys 1 AAPL Dec 245 Put at $10.50 on the same day. The maximum potential gain is…
1050
Breakeven
Unlimited
0

Answer: C

The Put is brought against the stock as a hedge. If the market falls below 245, the put will be exercised and the stock will be sold at 245. However, if the stock was to continue to rise, the put would expire with no value, and the profit potential on the stock would be unlimited.

12. A trader is looking to enter a trade on stock ABC that is currently trading at $100. The order that was placed with his broker was 1 ABC Jan 100 Call and Short 1 ABC Jan 105 Call. This position is considered?
A Bear Put Spread
A Bull Put Spread
A Bear Call Spread
A Bull Call Spread

Answer : D

This trade is considered to be a Bull Call Spread and is used when the market outlook is bullish on a stock.

13. What of the following trades can be used to hedge a short position of 300 shares of AAPL stock?
1 x ATM Long Put
1 x OTM Long Call
3 x ATM Long Call
3 x OTM Long Put

Answer: C

Typically when option traders are looking for a hedge against their position, they will want to purchase at-the-money option contracts. Since the trader has 300 shares of the stock, this means they are required to purchase 3 options contracts. And to offset the negative direction on the short stock, they will need to cover this using a Call Option.

14. A trader buys 100 shares of AAPL that are trading at $200. A month later the stock increases to $225. The trader believes that the market will stay near this price and decides to sell 1 AAPL Jun 225 Call @ $15.00. AAPL then goes to $185 and the call options expire and the stock is liquidated at current market price. What is the total overall profit or loss on this trade?
No gain or loss
1500 loss
2500 gain
3000 gain

Answer: A

There is no gain or loss on this trade. Since the stock was purchased at $200, and the call option was sold for $15, that means the traders breakeven was $185. Since the stock was sold at $185, the trader did not make or lose any money on this position.

Author: Options Academy

1. A trader buys 5 AAPL Jan 40 Calls @ $8.00 and sells 10 AAPL Jan 50 Calls @ $2.00 when the market price of AAPL is at 43. The position created is:
Ratio Spread
Calendar Spread
Vertical Spread
Call Spread

Answer: A

The trader created a 2×1 ratio call spread on AAPL

2. A trader sells 1 FB Dec 100 Call @ $10 when the stock price of FB is $95. The breakeven is:
$105
$100
$95
$110

Answer: D

The trader would have a breakeven calculated from short call + premium paid

3. A trader buys 100 shares of ABC stock at $50 and sells 1 ABC Jun 55 Call @ 3.00. The maximum loss is:
$5,000
$300
$5,300
$4,700

Answer : D

The stock can go to $0, causing the trader to lose $5000. The Call will then expire allowing the trader to collect the credit of $300. Therefore, the max loss on this trade is $4,700.

4. A trader has buys 1 XYZ Jun 50 Call and sells 1 XYZ Jun 55 Call on his books. What position does he have?
Long Put Spread
Long Calls
Long Strangle
Long Call Spread

Answer: The position created is a called a Long Call Spread

5. A trader buys 1 XYZ Jun 50 Call and sells 1 XYZ Sept 50 Call on his books. What position does he have?

Long Calendar Spread
Short Calendar Spread
Short Straddle
Long Straddle

Answer : B

6. A trader sells 1 ABC Jun 50 Call and buys 1 ABC Dec 50 Call. What position does he have?

Long Calendar Spread
Short Calendar Spread
Short Straddle
Long Straddle

Answer: A

7. If a trader wanted to go short a stock, but wanted to sell options, what possible trade could he place.

Short put
Short call
Long put
Long call

Answer : B

The sale of a short call is a short premium trade for going short instead of selling the stock directly. Like a stock, they both have unlimited upside risk. If the stock stays neutral, as a short call seller you will collect premium whereas a short stock position will not return any profits. Options contracts lose time premium as the position nears expiration; this is not true for stock positions.

8. When the market price of ABC stock is trading at $38 per share, which of the following choices creates a strangle?
Short 1 ABC Jan 40 put / short 1 ABC Jan 40 Call
Short 1 ABC Jan 40 put / short 1 ABC Jan 35 Cal
Short 1 ABC Jan 35 put / short 1 ABC Jan 40 Call
Short 1 ABC Jan 50 call / short 1 ABC Jan 40 Call

Answer C

A strangle is a specific variation of a combination, where both contracts are out the money.

9. When the market price of ABC stock is trading at $38 per share, which of the following choices creates an At-The-Money straddle?

short 2 ABC Jan 40 put / short 1 ABC Jan 40 Call
short 1 ABC Jan 45 call / short 1 ABC Jan 40 Call
short 1 ABC Jan 35 put / short 1 ABC Jan 45 Call
short 1 ABC Jan 40 put / short 1 ABC Jan 40 Call

Answer : D

A straddle is a specific variation of a combination, where both contracts are at the same strike.

10. The time value of 1 ABC Jun 310 Call trading at $10.00 with ABC trading at $315.58. is?
442.00
342.00
310.00
558.00

Answer : A

The current price closed at $315.58, so the contract is in the money by $5.58. Any premium above this is considered to be time premium. Therefore, since the contract is selling at $10 minus $5.58 = $4.42 time premium x 100 multiplier = $442.00

Author: Options Academy

Rho is the rate at which the price of an option changes relative to a change in interest rates. In other words, rho measures the sensitivity of an option’s price or a portfolio to a change in interest rates.

For example, if an option has a rho of 1.0, then for every 1% increase in interest rates, the value of the option will increase by one point.

When looking at rho, at-the-money options with longer-term expirations are most sensitive to a change in interest rates.

Call options typically increase in value with an increase in interest rates. For example, assuming that a call option is priced at $5 and has a rho of $0.50, then if the risk-free rate increases by 1%, the value of the call option will increase from $5 to $5.50.

Out of the five common greeks, traders typically refer most frequently to four important risk metrics: delta, gamma, theta, and vega. Rho is typically ignored and is considered to be the least important in terms of risk for options traders.

For day traders, rho is typically not an options greek that they will ever need to worry about.

Alternatively, if an investor was to purchase a LEAPS contract, or Long-term Equity AnticiPation Securities, which are options with expiration dates that go out as far as three years, they are at far greater risk to changes in the risk-free rate. Therefore, these options have larger values of rho compared to shorter-term options.
What is the Risk-Free Rate?

When discussing interest rates, it’s assumed that a risk-free rate is being referenced. The risk-free rate is the theoretical rate of return on an investment that has zero risk. While there is not actual risk-free investment, a good proxy would be investing in government bonds, such as Treasury bonds and Treasury bills.

This is considered as close as you can get to a risk-free investment because you can assume the government will not default, and you will be paid back on your bond or bill.

Risk-free investments are also known as the minimum return investment because, as an investor, you would expect a higher return anytime you have money at risk. No one will risk their money if they could make more money in a risk-free product.
Wrapping Up

Generally, interest rates do not affect an option’s premium as much as the time value, the underlying stock price, and volatility. However, in a highly volatile interest rate environment, rates matter. An increase in interest rates — as measured by the less-followed greek “Rho” will typically increase call prices and decrease put prices.

Author: Options Academy