Series 3 – The National Commodities Futures Test Options on Futures Contracts 1 — Questions and Answers
Question 1: What does purchasing a call option on a futures contract give the buyer the right to do?
- Sell the underlying futures contract at the strike price
- Buy the underlying futures contract at the strike price (Correct answer)
- Sell the underlying commodity at the current market price
- Buy the underlying commodity at a discount to market price
Correct answer: Buy the underlying futures contract at the strike price
A call option gives the buyer the right, but not the obligation, to buy the underlying futures contract at the specified strike price before expiration.
Question 2: What is the maximum loss a buyer of an options contract can incur?
- Unlimited loss potential
- The full value of the underlying futures contract
- The premium paid for the option (Correct answer)
- The initial margin requirement for the underlying futures
Correct answer: The premium paid for the option
The maximum loss for an options buyer is limited to the premium paid, since the buyer can simply allow the option to expire worthless if it is not profitable.
Question 3: Which of the following best describes a put option on a futures contract?
- The right to buy the underlying futures at the strike price
- The obligation to sell the underlying futures at market price
- The right to sell the underlying futures at the strike price (Correct answer)
- The obligation to buy the underlying futures at the strike price
Correct answer: The right to sell the underlying futures at the strike price
A put option gives the holder the right, but not the obligation, to sell the underlying futures contract at the specified strike price before expiration.
Question 4: What is the 'premium' of an options contract?
- The margin deposit required by the exchange to hold a futures position
- The price paid by the buyer to the writer to acquire the option (Correct answer)
- The profit earned when the option is exercised profitably
- The difference between the strike price and the current futures price
Correct answer: The price paid by the buyer to the writer to acquire the option
The premium is the price paid by the option buyer to the option seller (writer) in exchange for the rights conveyed by the option contract.
Question 5: A call option is considered 'in-the-money' when:
- The underlying futures price is below the strike price
- The underlying futures price equals the strike price exactly
- The underlying futures price is above the strike price (Correct answer)
- The time value of the option has fully eroded
Correct answer: The underlying futures price is above the strike price
A call option is in-the-money when the underlying futures price exceeds the strike price, giving the option positive intrinsic value if exercised.
Question 6: What is the 'intrinsic value' of an option?
- The time remaining until the option's expiration date
- The total premium originally paid for the option
- The amount by which an option is in-the-money (Correct answer)
- The implied volatility component embedded in the option's price
Correct answer: The amount by which an option is in-the-money
Intrinsic value is the amount by which an option is in-the-money, representing the immediate exercise value of the option at any given moment.
Question 7: Which component of an option's premium declines as the expiration date approaches, all else being equal?
- Intrinsic value
- Strike value
- Time value (Correct answer)
- Delta value
Correct answer: Time value
Time value (extrinsic value) declines as an option approaches its expiration date, a process known as time decay or theta decay.
Series 3 – The National Commodities Futures Test Options on Futures Contracts 1
What does purchasing a call option on a futures contract give the buyer the right to do?