Session 17 – Reading 73 Risk Management Applications of Option Strategies

CFA Level 1 – Derivative Investments, Session 17 – Reading 73

Risk Management Applications of Option Strategies – LOS a

(Notes, Practice Questions, Sample Questions)

1. Which of the following statements about put options is least accurate? The most the:

A) writer can gain is the put premium.
B) buyer can gain is unlimited. (Explanation — The most the put buyer can gain is the strike price of the stock less the premium)
C) writer can lose is the strike price less the premium.
2. A stock is trading at per share.

An investor believes that the stock will move either up or down. He buys a call option on the stock with an exercise price of $20. He also buys two put options on the same stock each with an exercise price of $25. The call option costs $2 and the put options cost $9 each. The stock falls to $17 per share at the expiration date and the investor closes his entire position. The investor’s net gain or loss is:

A) $4 gain.
B) $4 loss. (Explanation — The total cost of the options is $2 + ($9 × 2) = $20.
>At expiration, the call is worth Max [0, 17-20] = 0. Each put is worth Max [0, 25-17] = $8. The investor made $16 on the puts but spent $20 to buy the three options, for a net loss of $4)
C) $3 loss.
3. Linda Reynolds pays $2.45 to buy a call option with a strike price of $42. The stock price at which Reynolds earns $3.00 from her call option position is:

A) $47.45. (Explanation — To earn $3.00, the stock price must be above the strike price by .

00 plus the premium Reynolds paid to buy the option ($42.00+$3.00+$2.45))
B) $2.45.
C) $42.00
4. Al Steadman receives a premium of $3.80 for shorting a put option with a strike price of $64. If the stock price at expiration is $84, Steadman’s profit or loss from the options position is:

A) $3.80. (Explanation — The put option will not be exercised because it is out-of-the-money, MAX (0, X-S). Therefore, Steadman keeps the full amount of the premium, $3.80)
B) $23.80.
C) $16.20
5. Jimmy Casteel pays a premium of $1.60 to buy a put option with a strike price of $145. If the stock price at expiration is $128, Casteel’s profit or loss from the options position is:

A) $15.40. (Explanation — The put option will be exercised and has a value of $145-$128 = $17 [MAX (0, X-S)]. Therefore, Casteel receives $17 minus the $1.60 paid to buy the option. Therefore, the profit is $15.40 ($17 less $1.60))
B) $18.40.
C) $1.60
6. Suppose the price of a share of Stock A is $100. A European call option that matures one month from now has a premium of $8, and an exercise price of $100. Ignoring commissions and the time value of money, the holder of the call option will earn a profit if the price of the share one month from now:

A) decreases to $90.
B) increases to $106.
C) increases to $110 (Explanation — The breakeven point is the strike price plus the premium, or $100 + $8 = $108. Any price greater than this would result in a profit, and the only choice that exceeds this amount is $110)
7. An investor purchases a stock for $40 a share and simultaneously sells a call option on the stock with an exercise price of $42 for a premium of $3/share. Ignoring dividends and transactions cost, what is the maximum profit that the writer of this covered call can earn if the position is held to expiration?

A) $5. (Explanation — This is an out of the money covered call. The stock can go up $2 to the strike price and then the writer will get $3 for the premium, total $5)
B) $3.
C) $2.
8. An investor buys a call option that has an option premium of $5 and a strike price of $22.50. The current market price of the stock is $25.75. At expiration, the value of the stock is $23.00. The net profit/loss of the call position is closest to:

A) $4.50.
B) -$5.00.
C) -$4.50 (Explanation — The option is in-the-money by $0.50 ($23.00 – $22.50). The investor paid $5.00 for the call option, thus the net loss is –$4.50 ($0.50 – $5.00))
9. Which of the following statements regarding call options is most accurate? The:

A) call holder will exercise (at expiration) whenever the strike price exceeds the stock price.
B) breakeven point for the seller is the strike price minus the option premium.
C) breakeven point for the buyer is the strike price plus the option premium. (Explanation — The breakeven for the buyer and the seller is the strike price plus the premium. The call holder will exercise if the market price exceeds the strike price)

Remember! This is just a sample.

You can get a custom paper by one of our expert writers.

Get your custom essay

Helping students since 2015

Calculate the price
Make an order in advance and get the best price
Pages (550 words)
$0.00
*Price with a welcome 15% discount applied.
Pro tip: If you want to save more money and pay the lowest price, you need to set a more extended deadline.
We know how difficult it is to be a student these days. That's why our prices are one of the most affordable on the market, and there are no hidden fees.

Instead, we offer bonuses, discounts, and free services to make your experience outstanding.
How it works
Receive a 100% original paper that will pass Turnitin from a top essay writing service
step 1
Upload your instructions
Fill out the order form and provide paper details. You can even attach screenshots or add additional instructions later. If something is not clear or missing, the writer will contact you for clarification.
Pro service tips
How to get the most out of your experience with Homework Mules
One writer throughout the entire course
If you like the writer, you can hire them again. Just copy & paste their ID on the order form ("Preferred Writer's ID" field). This way, your vocabulary will be uniform, and the writer will be aware of your needs.
The same paper from different writers
You can order essay or any other work from two different writers to choose the best one or give another version to a friend. This can be done through the add-on "Same paper from another writer."
Copy of sources used by the writer
Our college essay writers work with ScienceDirect and other databases. They can send you articles or materials used in PDF or through screenshots. Just tick the "Copy of sources" field on the order form.
Testimonials
See why 20k+ students have chosen us as their sole writing assistance provider
Check out the latest reviews and opinions submitted by real customers worldwide and make an informed decision.
Technology
Thank you for your work
Customer 452551, October 22nd, 2021
Political science
I like the way it is organized, summarizes the main point, and compare the two articles. Thank you!
Customer 452701, February 12th, 2023
Business Studies
Great paper thanks!
Customer 452543, January 23rd, 2023
Finance
Thank you very much!! I should definitely pass my class now. I appreciate you!!
Customer 452591, June 18th, 2022
Accounting
Thank you for your help. I made a few minor adjustments to the paper but overall it was good.
Customer 452591, November 11th, 2021
Psychology
I requested a revision and it was returned in less than 24 hours. Great job!
Customer 452467, November 15th, 2020
Education
Thank you so much, Reaserch writer. you are so helpfull. I appreciate all the hard works. See you.
Customer 452701, February 12th, 2023
Psychology
Thank you. I will forward critique once I receive it.
Customer 452467, July 25th, 2020
Political science
Thank you!
Customer 452701, February 12th, 2023
11,595
Customer reviews in total
96%
Current satisfaction rate
3 pages
Average paper length
37%
Customers referred by a friend
OUR GIFT TO YOU
15% OFF your first order
Use a coupon FIRST15 and enjoy expert help with any task at the most affordable price.
Claim my 15% OFF Order in Chat
Show more
<