Topic 6 Solution.docx - Options Following is the solution...

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Options Following is the solution to some of the problems in Chapter 6. Note that all of the problems from this chapter are examinable. For further assistance, contact your lecturer. Problem 6.2 Call options provide the holder the right to purchase an underlying asset at a specified price (the strike price), for a certain period of time. If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless. Investors buy calls when they think the share price of the underlying security will rise or sell a call if they think it will fall. Selling a call option means the writer is (legally) obligated to seller the underlying security of the option is exercised. Put options give the holder the right to sell an underlying asset at a specified price. The seller (or writer) of the put option is obligated to buy the stock at the strike price. Put options can be exercised at any time before the option expires. Investors buy puts if they think the share price of the underlying stock will fall or sell one if they think it will rise. Put buyers, those who hold a “long” put, are either speculative buyers looking for leverage, or insurance buyers who want to protect their long positions in a stock for the period of time covered by the option. Put sellers hold a short, expecting the market to move upward, or at least stay stable. The maximum profit is limited to the put premium received and is achieved when the price of the underlying is at or above the option’s strike price at expiration. The maximum loss is unlimited for an uncovered put writer. Problem 6.4 What is the difference between a covered option and a naked option? Give an example of each.
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