Chapter 5 Practice Question Answers
1. Answer: A. On long calls, an investor’s maximum gain is unlimited.
2. Answer: B. On long calls, an investor’s breakeven is the strike price plus the premium paid. Thus, Sally’s breakeven is 32.50 (30 + 2.50).
3. Answer: B. For naked short calls, the investor’s maximum gain is the premium received. In this case, Jon receives $1,050 (3 x $3.50 x 100).
4. Answer: D. On long puts, an investor’s maximum gain is the strike price minus the premium times 100 (($30 – $2.5) x 100 = $2,750).
5. Answer: D. On short puts, an investor’s maximum loss is the strike price minus the premiums times the number of contracts times 100, which in this case is $11,000 (($30 – $2.5) x 4 x 100).
6. Answer: B. For puts, an option is in the money when the market price is below the strike price. In this case, the market price is above the strike price, so the option is out of the money.
7. Answer: A. For both long and short positions, call options are in the money when the market price is above the strike price. The intrinsic value is the amount that a stock is in the money. This is the difference between the market price and the strike price. In this case, it is $1 ($51 – $50).
8. Answer: C. For both long and short positions, put options are in the money when the market price is below the strike price. The intrinsic value is the amount that a stock is in the money. When an option is out of the money, the intrinsic value is always equal to $0. Because this option is out of the money at the time Sandy shorts it, its intrinsic value is $0.
9. Answer: B. For both long and short positions, put options are in the money when the market price is below the strike price. The intrinsic value is the amount a stock is in the money. When an option is out of the money, the intrinsic value is always equal to $0. Because this option is out of the money at the time Sandy shorts it