1
Q
Which of the following create a straddle?
ILong 1 ABC Jan 50 CallLong 1 ABC Apr 50 PutIIShort 1 ABC Jan 50 CallShort 1 ABC Jan 50 PutIIIShort 1 ABC Jan 50 CallLong 1 ABC Jan 50 PutIVShort 1 ABC Jan 50 CallShort 1 ABC Jan 60 Put
A. II only
B. I and III
C. II and IV
D. III and IV
A
The best answer is A.
A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.
2
Q
Which of the following create a straddle?
IShort 1 ABC Jan 50 CallShort 1 ABC Jan 50 PutIIShort 1 ABC Apr 50 CallShort 1 ABC Oct 50 PutIIIShort 1 ABC Jan 50 CallLong 1 ABC Jan 50 PutIVLong 1 ABC Jan 50 CallLong 1 ABC Jan 60 Put
A. I only
B. I and III
C. II and IV
D. III and IV
A
The best answer is A.
A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.
3
Q
Which of the following positions is a long straddle?
A. Long 1 ABC Jan 50 Call; Long 1 XYZ Jan 50 Put
B. Long 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Call
C. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 50 Put
D. Long 1 ABC Jan 50 Put; Short 1 ABC Jan 60 Put
A
The best answer is C.
A long straddle is created by purchasing a call and a put on the same stock, with the same strike price and expiration. Choice A has different stock positions. Choices B and D involve the purchase and sale of a call; or the purchase and sale of a put. These are spreads, which are covered in a later section
4
Q
A customer would buy a straddle because the customer:
A. is only bullish on the underlying security
B. is only bearish on the underlying security
C. believes that the market for the stock may be either bullish or bearish
D. wishes to generate some additional income from the underlying security during a period of market stability
A
The best answer is C.
A long straddle is the purchase of a call and the purchase of a put, on the same stock at the same strike price and expiration. If the market goes up, the long call goes “in the money” and the long put expires “out the money.” There is potentially unlimited profit on the long call. Conversely, if the market falls, the long put goes “in the money” and the long call expires “out the money.” The profit on the long put keeps increasing as the market falls, all the way to “0.” Thus, the position is profitable if the market either rises or falls. If the market stays the same and does not move, then both positions expire “at the money” and the premium paid is lost.
5
Q
On the same day in a cash account a customer purchases 1 MNO Mar 45 Call @ $5 and 1 MNO Mar 45 Put @ $3, when the market price of MNO is $46.13. Subsequently, MNO goes to $57 and the customer lets the put expire and closes the call at intrinsic value. The customer has:
A. $300 gain
B. $400 gain
C. $500 gain
D. $800 gain
A
The best answer is B.
This is a long straddle, which is the purchase of a call and a put on the same stock, with the same strike price and expiration.
Buy 1 MNO Mar 45 Call@ $5
Buy 1 MNO Mar 45 Put@ $3
———-
$8 Debit
If the market rises above $45, the put will expire “out the money” and the call goes “in the money.” If the market rises to $57, the call is 12 points “in the money” (or has intrinsic value of 12 points). If the call is now sold “at intrinsic value,” there is a 12 point proceeds from the sale of the call. Because, initially, a combined premium of 8 points was paid, the net profit is: 12 points - 8 points = 4 points or $400.
6
Q
On the same day in a cash account a customer purchases 1 ABC Mar 60 Call @ $7 and 1 ABC Mar 60 Put @ $2, when the market price of ABC is 61.63. Subsequently, ABC goes to $70 and the customer lets the put expire and closes the call at intrinsic value. The customer has a:
A. $100 gain
B. $200 gain
C. $700 gain
D. $1,000 gain
A
The best answer is A.
This is a long straddle, which is the purchase of a call and a put on the same stock, with the same strike price and expiration.
Buy 1 ABC Mar 60 Call@ $7
Buy 1 ABC Mar 60 Put@ $2
——-
$9 Debit
If the market rises above $60, the put will expire “out the money” and the call goes “in the money.” If the market rises to $70, the call is 10 points “in the money” (or has intrinsic value of 10 points). If the call is now sold “at intrinsic value,” there is a 10 point proceeds from the sale of the call. Because, initially, a combined premium of 9 points was paid, the net profit is: 10 points - 9 points = 1 point or $100.
7
Q
On the same day in a cash account, a customer purchases 1 MNO Mar 45 Call @ $3 and 1 MNO Mar 45 Put @ $1, when the market price of MNO is $44.38. Subsequently, MNO goes to $38 and the customer lets the call expire and closes the put at intrinsic value. The customer has:
A. $300 gain
B. $700 gain
C. $300 loss
D. $400 loss
A
The best answer is A.
This is a long straddle:
Buy 1 MNO Mar 45 Call@ $3
Buy 1 MNO Mar 45 Put@ $1
——
$4 Debit
If the market drops below $45, the call will expire “out the money” and the put goes “in the money.” Here the put is “in the money” (or has intrinsic value of) 7 points. This results in a 7 point profit on the put, if it is “closed” (sold) at intrinsic value. But, since 4 points were paid in premiums, the customer has a net gain of 3 points per share, or $300.
8
Q
A customer buys 1 ABC Jul 65 Call @ $7 and buys 1 ABC Jul 65 Put @ $5 when the market price of ABC is $66. The breakeven points are:
A. $60 and $72
B. $58 and $70
C. $63 and $67
D. $53 and $77
A
The best answer is D.
Long straddles are profitable if the market either moves up or down. To breakeven, the total premium paid must be recovered by the market moving either up or down. To breakeven, the holder must recover the 12 point debit paid for the straddle. If the market rises, the call side goes “in the money” and can be exercised or closed for a profit. To recover the 12 point debit, the market must rise to $65 + $12 = $77. If the market falls, the put side of the straddle goes “in the money” and can be exercised or closed for a profit. To recover the 12 point debit, the market must fall to $65 - $12 = $53, To summarize, the breakeven formulas for a long straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
9
Q
A customer buys 1 ABC Jan 75 Call @ $9 and buys 1 ABC Jan 75 Put @ $6 when the market price of ABC = $77. The breakeven points are:
A. $81 and $84
B. $90 and $60
C. $66 and $69
D. $90 and $96
A
The best answer is B.
Long straddles are profitable if the market either moves up or down. To breakeven, the total premium paid must be recovered by the market moving either up or down. To breakeven, the $15 debit paid for the straddle must be gained back. This happens at 75 + 15 = $90 on the call side of the straddle and 75 - 15 = $60 on the put side of the straddle. To summarize, the breakeven formulas for a long straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
10
Q
A customer buys 5 ABC Jan 60 Calls @ $4 and buys 5 ABC Jan 60 Puts @ $1 on the same day when the market price of ABC stock is $62. The customer’s maximum potential gain is:
A. $500
B. $2,500
C. $27,500
D. unlimited
A
The best answer is D.
The positions created by the customer are:
Long 5 ABC Jan 60 Calls@ $4
Long 5 ABC Jan 60 Puts@ $1
$5 debit x 5 contracts = $2,500 debit
The customer created a long straddle, which is the purchase of a call and a put on the same stock, with the same strike price and expiration. If the market stays exactly at 60, both the calls and puts expire “at the money” and the customer loses $2,500. If the market rises, the calls go “in the money” and the puts expire. The customer has unlimited upside gain potential on the calls. Conversely, if the market drops, the puts go “in the money” and the calls expire. The maximum potential gain on the downside is the strike price of the put (60) less the debit of 5 = $55 per share x 500 shares = $27,500.
11
Q
A customer buys 1 ABC Jan 65 Call @ $7 and buys 1 ABC Jan 65 Put @ $2 when the market price of ABC = $64. The maximum potential loss is:
A. $200
B. $700
C. $900
D. unlimited
A
The best answer is C.
If the market stays at $65, both contracts expire “at the money.” The customer loses the $900 paid in premiums. This is the maximum potential loss.
12
Q
A customer buys 1 ABC Jan 70 Call @ $4 and buys 1 ABC Jan 70 Put @ $1 on the same day when the market price of ABC stock is $72. Assume that the market price falls to $66 and the call premium falls to $.50, while the put premium rises to $5.50. The customer closes the positions. The customer has a:
A. $100 gain
B. $100 loss
C. $500 gain
D. $500 loss
A
The best answer is A.
The customer established two positions with a debit of $5 x 1 contract = $500 debit. When the market is at $66, the customer closes the call at $.50 and closes the put at $5.50. Thus, the positions are closed at:
Short 1 ABC Jan 70 Call@ $ .50
Short 1 ABC Jan 70 Put@ $5.50
$6.00 credit = $600 credit
The customer closed for a credit of $600. Since the initial positions cost $500, the customer has a $100 gain.
13
Q
A customer buys 1 ABC Jan 70 Call @ $5 and buys 1 ABC Jan 70 Put @ $6 when the market price of ABC is $71. At which market prices is the position profitable?I $57II $59III $81IV $84
A. I and IV only
B. II and III only
C. II and IV only
D. I, II, III, IV
A
The best answer is A. A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $11 in premiums was paid, the market must move down by more than 11 points to profit on the put; or must move up by more than 11 points to profit on the call. Thus, the position is profitable either below $70 - $11 = $59; or above $70 + $11 = $81. Thus, the profitable prices here are $57 and $84. At $59 or $81, the customer breaks even. To summarize, the breakeven formulas for a long straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
14
Q
A customer buys 1 ABC Jan 50 Call @ $4 and buys 1 ABC Jan 50 Put @ $6 when the market price of ABC is $49. At which market prices is the position profitable?
I$39
II$40
III$60
IV$61
A. I and IV only
B. II and III only
C. II and IV only
D. I, II, III, IV
A
The best answer is A.
A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $10 in premiums was paid, the market must move down by more than 10 points to profit on the put; or must move up by more than 10 points to profit on the call. Thus, the position is profitable at either $39 or $61. Note that $40 and $60 are the breakeven points. To summarize, the breakeven formulas for a long straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
15
Q
A customer buys 1 ABC Jan 50 Call @ $3 and buys 1 ABC Jan 50 Put @ $6 when the market price of ABC is $48. At which market prices is the position profitable?
I$44
II$41
III$40
IV$36
A. I and IV only
B. II and III only
C. II and IV only
D. III and IV only
A
The best answer is D.
A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $9 in premiums was paid, the market must move down by more than 9 points to profit on the put; or must move up by more than 9 points to profit on the call. Thus, the position is profitable either below $50 - $9 = $41; or above $50 + $9 = $59. Thus, the profitable prices here are $40 and $36. To summarize, the breakeven formulas for a long straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
16
Q
A customer who is short 1 ABC Jan 50 Call wishes to create a “short straddle.” The second option position that the customer must take is:
A. Long 1 ABC Jan 50 Call
B. Long 1 ABC Jan 50 Put
C. Short 1 ABC Jan 50 Call
D. Short 1 ABC Jan 50 Put
A
The best answer is D.
A short straddle consists of a short call and a short put on the same stock, with both contracts having the same strike price and expiration. With a short straddle, the customer is hoping that the market remains flat; he loses if the market goes either up or down. If the market rises, the customer loses on the short naked call (the put expires). If the market falls, the customer loses on the short naked put (the call expires). If the market stays the same, both contracts expire “at the money” and the customer gains both premiums collected.
17
Q
A short straddle is profitable in a:
Irising market
IIfalling market
IIIstable market
A. I only
B. III only
C. II and III
D. I, II, III
A
The best answer is B.
A short straddle is the sale of a call and the sale of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised and the writer will lose. If the market moves down, the put will be exercised and the writer will lose. Thus, a short straddle is only profitable if the market does not move - thus it is profitable in a stable market.
18
Q
On the same day, a customer:
Sells 1 ABC Jan 45 Call@ $4
Sells 1 ABC Jan 45 Put@ $3
At that time, the market price of ABC is $44. If the market rises to $58 and the call is exercised (the put expires out the money), the gain or loss is:
A. $600 loss
B. $700 loss
C. $700 gain
D. $1,300 gain
A
The best answer is A.
If the market rises to $58, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $45 on the short call. Since the price in the market is $58, the customer loses 13 points. After deducting the 7 points of premiums collected, the net loss is 6 points or $600.
19
Q
On the same day, a customer:
Sells 1 ABC Jan 65 Call@ $6
Sells 1 ABC Jan 65 Put@ $6
At that time, the market price of ABC is $65. If the market rises to $78 and the call is exercised (the put expires out the money), the gain or loss is:
A. $100 loss
B. $100 gain
C. $1,200 gain
D. $1,300 gain
The best answer is A.
If the market rises to $78, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $65 on the short call. Since the price in the market is $78, the customer loses 13 points. After deducting the 12 points of premiums collected, the net loss is 1 point or $100.
20
Q
On the same day, a customer:
Sells 1 ABC Jan 50 Call@ $3
Sells 1 ABC Jan 50 Put@ $5
The market price of ABC at that time is $48. If the market rises to $60 and the call is exercised (the put expires out the money), the gain or loss is:
A. $200 loss
B. $700 loss
C. $800 gain
D. $1,000 gain
A
The best answer is A.
If the market rises to $60, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $50 on the short call. Since the price in the market is $60, the customer loses 10 points. After deducting the 8 points of premiums collected, the net loss is 2 points or $200.
21
Q
A customer shorts 1 ABC Jan 35 Straddle for a total premium of $350. At expiration, ABC closes at $29 and the customer is exercised. As a result, the customer will have a:
A. $250 loss
B. $600 gain
C. $600 loss
D. $950 gain
A
The best answer is A.
When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:
Sells 1 ABC Jan 35 Call
Sells 1 ABC Jan 35 Put
$350 Credit
If the market stays exactly at $35, both positions expire and the customer would gain the $350 credit. In this case, the market declines to $29. The call expires “out the money,” while the put is 6 points “in the money” and will be exercised at a loss of 6 points = $600 loss. Since $350 was received in premiums, the net loss is $250.
22
Q
A customer sells 1 ABC Jan 30 Straddle for a total premium of $500. At expiration, ABC closes at $21 and the customer is exercised. As a result, the customer will have a:
A. $100 gain
B. $400 gain
C. $400 loss
D. $900 gain
A
The best answer is C.
When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:
Sells 1 ABC Jan 30 Call
Sells 1 ABC Jan 30 Put
$500 Credit
If the market stays exactly at $30, both positions expire and the customer would gain the $500 credit. In this case, the market declines to $21. The call expires “out the money,” while the put is 9 points “in the money” and is exercised at a loss of 9 points = $900 loss. Since $500 was received in premiums, the net loss is $400.
23
Q
A customer sells 5 ABC Jan 30 Straddles for a total premium of $3,500. At expiration, ABC closes at $21, and the customer is exercised. As a result, the customer will have a:
A. $1,000 gain
B. $1,000 loss
C. $3,500 gain
D. $3,500 loss
A
The best answer is B.
When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:
Sells 5 ABC Jan 30 Calls
Sells 5 ABC Jan 30 Puts
$700 Credit x 5 = $3,500 Credit
If the market stays exactly at $30, both positions expire and the customer would keep the $3,500 credit. In this case, the market declines to $21. The calls expire “out the money,” while the puts are 9 points “in the money” and will be exercised at a loss of 9 points = $900 per contract = $4,500 loss on 5 contracts. Since $3,500 was collected in premiums, the net loss is $1,000.
24
Q
On the same day, a customer:
Sells 1 ABC Jan 50 Call@ $3
Sells 1 ABC Jan 50 Put@ $5
At that time, the market price of ABC is $48. The breakeven points are:
I$42
II$45
III$53
IV$58
A. I and III
B. I and IV
C. II and III
D. II and IV
A
The best answer is B.
The writer of the straddle collected 8 points in premiums. The writer loses the 8 points to breakeven if the market falls by that amount or rises by the amount. If the market falls by 8 points, the writer loses 8 points on the put and the call expires. The breakeven on the put side of the straddle is $50 - $8 = $42. If the market rises by 8 points, the writer loses 8 points on the call and the put expires. The breakeven on the call side of the straddle is $50 + $8 = $58. To summarize, the breakeven formulas for a short straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
25
Q
A customer sells 1 ABC Jan 50 Call @ $5.75 and 1 ABC Jan 50 Put @ $2.25 when the market price of ABC is at $50.75. The maximum potential gain is:
A. $75
B. $225
C. $800
D. unlimited
A
The best answer is C.
The positions created by the customer are:
Short 1 ABC Jan 50 Call@ $5.75
Short 1 ABC Jan 50 Put @ $2.25
$8.00 credit
If the market stays exactly at 50, both the calls and puts expire “at the money” and the customer gains 8 points, or $800. This is the maximum potential gain. If the market rises, the call goes “in the money” and the put expires. The customer has unlimited loss potential on the call. Conversely, if the market drops, the put goes “in the money” and the call expires. The maximum potential loss on the downside is the strike price of the put (50) less the credit of 8 = $42 per share x 100 shares = $4,200 loss.
26
Q
A customer sells 1 ABC Jul 35 Call @ $4 and sells 1 ABC Jul 35 Put @ $3 when the market price of ABC is $37. The maximum potential loss is:
A. $400
B. $700
C. $3,700
D. unlimited
A
The best answer is D.
Since one side of a short straddle is a short naked call, if the market rises there is unlimited risk.
27
Q
A customer sells 1 ABC Jan 30 Call @ $5 and sells 1 ABC Jan 30 Put @ $4 on the same day when the market price of ABC stock is $31. Assume that the market price rises to $38 and the call premium rises to $12, while the put premium falls to $1. The customer closes the positions. The gain or loss is:
A. $400 loss
B. $400 gain
C. $900 gain
D. $1,300 loss
A
The best answer is A.
The customer established two positions with a credit of $9 x 1 contract = $900 credit. When the market is at $38, the customer closes the call at $12 and closes the put at $1. Thus, the positions are closed at:
Buy 1 ABC Jan 30 Call@ $12
Buy 1 ABC Jan 30 Put@ $ 1
$13 debit = $1,300 debit
The customer closed for a debit of $1,300. Since the initial credit was $900, the customer has a $400 loss.
28
Q
A customer sells 1 ABC Jan 45 Call @ $7 and sells 1 ABC Jan 45 Put @ $3 on the same day when the market price of ABC stock is $49. Assume that the market price falls to $44 and the call premium falls to $5, while the put premium rises to $7. The customer closes the positions. The gain or loss is:
A. $200 gain
B. $200 loss
C. $1,000 gain
D. $1,200 loss
A
The best answer is B.
The customer established two positions with a credit of $10 x 1 contract = $1,000 credit. When the market is at $44, the customer closes the call at $5 and closes the put at $7. Thus, the positions are closed at:
Buy 1 ABC Jan 45 Call@ $ 5
Buy 1 ABC Jan 45 Put@ $ 7
$12 debit = $1,200 debit
The customer closed for a debit of $1,200. Since the initial credit was $1,000, the customer has a $200 loss.
29
Q
If the price of the underlying security remains unchanged until expiration, which of the following options investors may have a profit?
IBuyer of an “at the money” Put
IISeller of an “at the money” Put
IIIBuyer of a Straddle
IVSeller of a Straddle
A. I and III
B. I and IV
C. II and III
D. II and IV
A
The best answer is D.
If the market price remains the same at expiration, “at the money” options contracts will expire. This means that the writer of the contract will earn the premium and the holder will lose the premium.
Since a long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration, the buyer of an “at the money” straddle will lose the premiums paid if the stock price remains unchanged because both positions will expire. On the other hand, the writer of that straddle, the sale of a call and a put on the same stock, will earn the premiums.
30
Q
A client with a high risk tolerance anticipates that the market will remain flat for the next 3 months. Which position would produce the maximum profit for this client?
A. Short Straddle
B. Long Strangle
C. Short Stock
D. Long Stock
A
The best answer is A.
Assume that the market price of a stock is at $50. A customer could:
Sell 1 ABC Jan 50 Call @$5
Sell 1 ABC Jan 50 Put @$5
Credit$10
This is a short straddle. If the market price stays at $50 until expiration, both positions expire “at the money” and the $10 credit is earned. Of course, if the market moves sharply up or down, the customer loses on the short naked call or short naked put, respectively.
A Long Straddle (or Long Strangle, which is a straddle with different strike prices) is profitable only if the market moves sharply either way. In a flat market, both long positions expire and the premium paid is lost.
Stock positions, either long or short, are not profitable in flat markets, other than any dividends received on long stock positions.
31
Q
A customer sells 1 ABC Jan 50 Call @ $3 and sells 1 ABC Jan 50 Put @ $6 when the market price of ABC is $48. At which market prices is the position profitable?
I$44
II$42
III$40
IV$38
A. I and II only
B. II and III only
C. I and IV only
D. III and IV only
A
The best answer is A.
A short straddle is the sale of a call and the sale of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. If the market stays at the strike price, then both contracts expire “at the money,” and the premiums collected represent the maximum gain. Since $9 in premiums was collected, the market must move down by more than 9 points to lose on the put; or must move up by more than 9 points to lose on the call. Thus, the position is unprofitable if the market moves below $50 - $9 = $41 per share; or moves above $50 +$9 = $59 per share. The position would be profitable between $42 and $58 per share. To summarize, the breakeven formulas for a short straddle are:
Upside Breakeven = Call strike Price + Combined Premiun
Downside Breakeven = Put Strike Price - Combined Premium
32
Q
Which TWO of the following choices are “combinations”?
ILong 1 ABC Jan 50 Call; Long 1 ABC Apr 60 Put
IILong 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Call
IIIShort 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Put
IVShort 1 ABC Jan 60 Call; Long 1 ABC Jan 50 Put
A. I and III
B. III and IV
C. I and IV
D. II and III
A
The best answer is A.
A “straddle” is the purchase of a call and put; or the sale of a call and put; with the same strike prices and expirations. A “combination” is the same as a straddle, except that the strike prices and/or expirations are different.
33
Q
Which TWO choices are “combinations”?
ILong 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Call
IILong 1 ABC Jan 60 Put; Short 1 ABC Jan 50 Put
IIILong 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put
IVShort 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Put
A. I and II
B. III and IV
C. I and IV
D. II and III
A
The best answer is B.
A “straddle” is the purchase of a call and put; or the sale of a call and put; with the same strike prices and expirations. A “combination” is the same as a straddle, except that the strike prices and/or expirations are different.
34
Q
A customer owns 200 shares of XYZ stock purchased at $40. The stock rises to $50, and the customer purchases 2 XYZ Jan 50 Puts @ $3 and buys 1 XYZ Apr 60 Call @ $2. A few weeks later, when the stock is at $55, the customer sells the stock and buys another XYZ Apr 60 Call @ $3. The customer remaining position is a:
A. spread
B. straddle
C. collar
D. combination
A
The best answer is D.
There sure is a lot going on here. After all is said and done, the customer is left with:
Long:2 XYZ Jan 50 Puts
Long:2 XYZ Apr 60 Calls
This is a long combination, also called a long strangle. A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. A long combination (long strangle) is the purchase of a call and a put on the same stock with a different strike price and/or expiration.
This is a strategy for expected volatility. If the stock drops below $50, the customer has a profit on the long puts and the long calls expire. If the stock rises above $60, the customer has a profit on the long calls and the puts expire. If the stock stays between $50 and $60, the customer will lose, having paid premiums for contracts that will expire “out the money.”
35
Q
Which of the following positions creates a “strangle” if the market price of ABC stock is $52 per share?
IBuy 1 ABC Jan 55 Call
IIBuy 1 ABC Jan 50 Call
IIIBuy 1 ABC Jan 55 Put
IVBuy 1 ABC Jan 50 Put
A. I and II
B. III and IV
C. I and III
D. I and IV
A
The best answer is D.
A “strangle” is a specific variation of a combination, where both contracts are “out the money.” A long strangle is the purchase of an “out the money” call and an “out the money” put. Only Choice D fits this definition.
Buy 1 ABC Jan 55 Call
Buy 1 ABC Jan 50 Put
This would be done when the market price is between $50 and $55. Both contracts are “out the money” and the premiums paid would be lower than if a long straddle was purchased. To profit, the price must move up sharply above $55 by at least the amount of premiums paid; or must move down sharply below $50 by at least the amount of premiums paid. This is a volatility strategy, similar to a long straddle.
36
Q
A customer buys 1 ABC Jul 55 Call @ $2 and 1 ABC Jul 60 Put @ $5 on the same day. Just prior to expiration, the stock is trading at $59 and the customer closes the positions at intrinsic value. The customer has a net loss of:
A. $50
B. $100
C. $200
D. $700
A
The best answer is C.
The customer has purchased a long combination, for combined premiums of $700. When the stock is at $59, the long 60 put is 1 point “in the money,” resulting in a 1 point gain to the holder while the long 55 call is 4 points “in the money,” resulting in a 4 point gain to the holder. $700 paid in premiums minus a $500 profit = $200 loss.
37
Q
A customer buys 1 ABC Jul 55 Call @ $6 and 1 ABC Jul 65 Put @ $6 on the same day. Just prior to expiration, the stock is trading at $63 and the customer closes the positions at intrinsic value. The customer has a net loss of:
A. $200
B. $400
C. $800
D. $1,200
A
The best answer is A.
The customer has purchased a long combination, for combined premiums paid of $1,200. When the stock is at $63, the long 65 put is 2 points “in the money,” resulting in a 2 point gain to the holder while the long 55 call is 8 points “in the money,” resulting in an 8 point gain to the holder. $1,200 paid in premiums minus a net of $1,000 received = $200 loss.
