Chapter Two
Basic Principles of Options
Answers to Problems and Questions
1. Up
2. False. The owner of an option has the right to do something, while the writer
has an obligation to perform if the option owner exercises.
3. The term “wasting asset” refers to the fact that because of time value decay,
the option’s value will necessarily decline if nothing else changes.
4. False. One person might write 50 contracts, and twenty-five different people
might buy a portion of them.
5. By selling an option rather than exercising it you recover any remaining time
value. Also, exercise may require a substantial cash outlay.
6. Because of their fungible nature, all option contracts with similar
characteristics are identical. When two closing transactions are matched up in
a trade, the contract disappears.
7. Buying a call requires a cash outlay (a disadvantage) but involves a known and
limited maximum loss (an advantage). Writing a put brings cash in (an
advantage) but can result in large losses if the stock drops sharply (a
disadvantage).
8. Any of the options with a striking price of 27.50 are near-the-money.
9. As the underlying asset moves through a wide price range, the OCC will create
more striking prices. Less volatile securities usually have fewer striking
prices.
10. An American option should always sell for at least as much as a European style
option because the American option gives you more flexibility than the
European option without giving anything up.
11. This is true, although the time value may be very small.
12. True, by definition.
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Chapter Two. Basic Principles of Options
13. This is false. While it is possible to gamble using options, they serve a valid
risk management purpose.
14. You can also make a profit if you sell the option for more than you paid for it
prior to option expiration.
15. False. An at-the-money option has intrinsic value of zero.
however, can be positive.
Its time value,
16. If the out-of-the-money put has considerably longer until expiration, its added
time value could be greater than the premium of the in-the-money option.
17. False. Writing an option, by definition, means selling an option as an opening
transaction.
18. False. The number of option contracts in existence may change continuously.
19. Prior to option expiration the option will have some time value. The profit and
loss diagrams look at intrinsic value only.
20. The option premium does not count as part of the purchase price. A down
payment is part of the purchase price.
21. 4.50 – (28.51 – 25) = 0. 99
22. 28.51 – 22.50 = 6.01
23. max (0, 22.50 – 28.51) = 0
24. 1.85
25. (32.50 – 31.25) – 4.20 = –2.95 (loss)
26. infinity
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Chapter Two. Basic Principles of Options
27.
25
29.20
4.20
28.
1.85
31.85
30
29.
28.40
28.40
35
6.60
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Chapter Two. Basic Principles of Options
30.
3.30
26.70
30
26.70
31. 3.70 – (28.51 – 25) = 0.19
32. 0
33. 35 – 28.51 = 6.49
34. 0.20
35. loss of (30 – 29) – 2.75 = –1.75
36. infinite
37.
30
31.55
1.85
38.
6.06
22.50
4
28.56
Chapter Two. Basic Principles of Options
39.
26.95
27.50
26.95
0.55
40.
2.00
28.00 30
28.00
41. MSQIG
42. MSQPE
43. MSQIF
44. MSQMX
45.
0.30
46.
1.00
47.
22,885
5