Series 3 – The National Commodities Futures Test Options on Futures Contracts 2 — Questions and Answers
Question 1: What does it mean to 'write' an options contract?
- To record the purchase of an option in a brokerage account in writing
- To sell an option, becoming the grantor of the rights conveyed (Correct answer)
- To exercise an option before its expiration date
- To transfer an existing option position to another party
Correct answer: To sell an option, becoming the grantor of the rights conveyed
Writing an option means selling the option contract; the writer receives the premium but assumes the obligation to perform if the buyer chooses to exercise.
Question 2: What is the maximum loss potential for a writer (seller) of an uncovered call option?
- Limited to the premium received for writing the option
- Limited to the strike price of the option contract
- Limited to the margin requirement set by the exchange
- Theoretically unlimited (Correct answer)
Correct answer: Theoretically unlimited
An uncovered (naked) call writer faces theoretically unlimited loss because there is no ceiling on how high the underlying futures price can rise against the short call position.
Question 3: A put option is 'out-of-the-money' when:
- The underlying futures price is below the strike price
- The underlying futures price is above the strike price (Correct answer)
- The option has no time value remaining before expiration
- The option premium exceeds the value of the underlying futures contract
Correct answer: The underlying futures price is above the strike price
A put option is out-of-the-money when the underlying futures price is above the strike price, meaning immediate exercise would not be profitable.
Question 4: What is 'delta' in the context of options on futures?
- The change in an option's time value relative to time passing
- The change in an option's premium for a one-unit change in the underlying futures price (Correct answer)
- The difference between the call premium and put premium at the same strike price
- The implied volatility measure embedded in the option's price
Correct answer: The change in an option's premium for a one-unit change in the underlying futures price
Delta measures the rate of change in an option's premium relative to a one-unit change in the price of the underlying futures contract.
Question 5: Which factor, when it increases, generally causes options premiums to rise?
- Time to expiration decreasing toward zero
- Volatility of the underlying futures price (Correct answer)
- The option moving further out-of-the-money
- Short-term interest rates declining
Correct answer: Volatility of the underlying futures price
Higher volatility increases the probability that an option will move in-the-money before expiration, which increases the option's premium.
Question 6: What happens to the premium paid for an option that expires out-of-the-money?
- It is returned to the option buyer by the exchange
- It is retained in full by the option writer as profit (Correct answer)
- It is held in an escrow account by the clearinghouse
- It is applied as credit toward the next options contract purchased
Correct answer: It is retained in full by the option writer as profit
When an option expires worthless (out-of-the-money), the entire premium paid is kept by the option writer as profit since no exercise occurs.
Question 7: An options holder who wants to close out their long position before expiration without exercising typically does so by:
- Letting the option expire and collecting a residual payment
- Requesting the exchange to cancel the outstanding contract
- Selling an identical option in the market to create an offsetting position (Correct answer)
- Delivering the underlying commodity to satisfy the contract
Correct answer: Selling an identical option in the market to create an offsetting position
An option holder can close their position before expiration by executing an offsetting sale of the same option in the market, eliminating their obligation.
Series 3 – The National Commodities Futures Test Options on Futures Contracts 2
What does it mean to 'write' an options contract?