Ch2Sols - 2-1CHAPTER 2: THE STRUCTURE OF OPTIONS...

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Unformatted text preview: 2-1CHAPTER 2: THE STRUCTURE OF OPTIONS MARKETSEND-OF-CHAPTER QUESTIONS AND PROBLEMS1.a.Homeowners insurance is a put option. In the event of a loss, the insurance company pays you aportion of the value of the house. The rest is like a deductible. The premium on the put is theinsurance premium.b.The guaranteed tuition arrangement is a call option granted to you by the school. If you enroll now,you can "purchase" the education at a fixed price up through the next four years. The premium on theoption is the fact that you have to enroll in this particular school for your freshman year. Of courseyou do not have to exercise the option by continuing to enroll thereafter.c.This is not an option because no one has the opportunity to forego exercise. It is actually a forwardcontract. If the lease were cancelable over the period during which the rental rate was fixed, it wouldbe a call option.2.An American option can be exercised at any time up through the expiration date. A European option can beexercised only on the expiration date. An American option is equivalent to a European option with theadditional feature that it can be exercised early.3.The option is on AT&T stock. It expires in January. If it is an exchange-listed option, it expires the Saturdayfollowing the third Friday in January. The option is a call with an exercise price of $65 a share. In other words,the option gives the right to buy AT&T stock at $65 a share up to the expiration day in January.4.a.One contract would now cover 110 shares with an exercise price of 60/1.10 or 54.55. This would berounded to the nearest eighth for 54-1/2.b.Buyers and writers of outstanding contracts are credited with two contracts for every one previouslyowned or written. The exercise price is changed to 12-1/2. The contract size is still 100.c.One contract would now cover 100(4/3) or 133 shares with an exercise price of 85(3/4) or 63.75. Note: In the context of options, a 4-for-3 stock split is the same as a 33 percent stock dividend.d.No changes to any contract terms.5.Jan cycleFeb cycleMarch cyclea.Feb, Mar, Apr, JulFeb, Mar, May, AugFeb, Mar, Jun, Sepb.Jul, Aug, Oct, JanJul, Aug, Nov, FebJul, Aug, Sep, Decc.Dec, Jan, Apr, JulDec, Jan, Feb, MayDec, Jan, Mar, Jun6.Short puts and long calls are both strategies designed to profit in a bullish market. Thus, they are considered tobe "on the same side of the market."7.The market maker is an independent operator whose objective is to buy options at one price and sell them for ahigher price. A broker is in business to generate commissions on each transaction. A broker does not have totry to guess where the market is going or whether he can earn the bid-ask spread.CBOE rules allow an individual to be both a market maker and a floor broker but not on the same day. Thereason is the potential for a conflict of interest. For example, suppose a situation arises in which the trader hasto decide whether to execute a personal transaction or a customer transaction. Whichever transaction is done2-2...
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Ch2Sols - 2-1CHAPTER 2: THE STRUCTURE OF OPTIONS...

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