Stock Trading Stock Trading Options & Derivatives 1 — Questions and Answers
Question 1: A call option gives the buyer the right, but not the obligation, to:
- Sell shares at the strike price before expiration
- Buy shares at the strike price before expiration (Correct answer)
- Receive dividends from the underlying stock
- Short the underlying stock at market price
Correct answer: Buy shares at the strike price before expiration
A call option grants the holder the right to purchase the underlying asset at the specified strike price on or before the expiration date.
Question 2: A call option is considered 'in the money' (ITM) when:
- The strike price equals the current stock price
- The strike price is above the current stock price
- The strike price is below the current stock price (Correct answer)
- The option has more than 30 days to expiration
Correct answer: The strike price is below the current stock price
A call is in the money when the underlying stock's market price exceeds the strike price, giving it intrinsic value.
Question 3: What is the maximum loss a buyer of a call option can incur?
- Unlimited losses as the stock falls
- The full value of the underlying shares
- The premium paid for the option (Correct answer)
- The difference between the strike price and zero
Correct answer: The premium paid for the option
An option buyer's maximum loss is limited to the premium paid, because they can simply let the option expire worthless.
Question 4: What does the 'strike price' of an option represent?
- The current market price of the underlying stock
- The price at which the option contract was purchased
- The predetermined price at which the option can be exercised (Correct answer)
- The price the stock must reach for the option to expire worthless
Correct answer: The predetermined price at which the option can be exercised
The strike price (also called exercise price) is the fixed price specified in the option contract at which the holder can buy or sell the underlying asset.
Question 5: Which options Greek measures the rate at which an option loses value as it approaches expiration?
- Delta
- Vega
- Gamma
- Theta (Correct answer)
Correct answer: Theta
Theta measures time decay — the daily erosion of an option's extrinsic (time) value as the expiration date approaches, assuming all else equal.
Question 6: A put option gives the holder the right to:
- Buy the underlying asset at the strike price
- Sell the underlying asset at the strike price (Correct answer)
- Receive the underlying asset's dividends
- Lock in the current market price for future purchase
Correct answer: Sell the underlying asset at the strike price
A put option grants the holder the right to sell the underlying asset at the strike price before or at expiration, making it profitable when the stock declines.
Question 7: What is the key difference between American-style and European-style options?
- American options expire monthly; European options expire quarterly
- American options can be exercised any time before expiration; European options only at expiration (Correct answer)
- American options are traded on US exchanges; European options trade in Europe only
- American options cover 100 shares; European options cover 10 shares
Correct answer: American options can be exercised any time before expiration; European options only at expiration
American-style options allow the holder to exercise at any point up to and including the expiration date, while European-style options can only be exercised on the expiration date itself.
Stock Trading Stock Trading Options & Derivatives 1
A call option gives the buyer the right, but not the obligation, to: