Quiz
CHAPTER 5 Hitting Moving Targets 77
2. What is intrinsic value?
(a) The difference between the premium and the CMV (b) The amount by which an option is in-the-money (c) The spread between the striking price and the CMV (d) The value, if any, at expiration
(e) All of the above (f) None of the above
3. What price would the underlying stock have to reach to be at breakeven if a 70 June call cost 2 points and the transaction costs were another point?
(a) 671⁄2 (b) 73 (c) 65 (d) 67
4. The maximum profit from a call is (a) strike price plus CMV.
(b) strike price minus premium plus transaction costs.
(c) infinity minus premium and transaction costs.
(d) the difference between CMV and the premium plus transaction costs.
5. Traders use the Black-Scholes model to find which of the following?
(a) Intrinsic value (b) Implied volatility
(c) The theoretical value of an option at some time in the future (d) Which options are over- or underpriced
6. Historical volatility provides a clue as to how explosive the price of a stock may be in the future.
(a) True (b) False
7. Pricing models provide which of the following?
(a) A blueprint for a trade (b) The best trading strategy
(c) An estimate of where an option’s price will be at some time in the future
(d) Trade entry and exit points 8. The value of price models is that they
(a) help the analyst define the pricing problem.
(b) foretell the future for the analyst.
(c) are 100 percent foolproof.
(d) are of no use in projecting future price trends.
9. Most option-pricing models use which of the following variables?
(a) The amount of time to expiration (b) The price of the underlying security (c) The striking or exercise price
(d) The carrying charges, such as dividends, interest, and so on (e) Volatility
(f) The breakeven price
10. The maximum profit for the buyer of a put is (a) the premium.
(b) the CMV minus the premium and transaction costs.
(c) the strike price minus the premium and transaction costs.
(d) infinity minus the premium and transaction costs.
Answers
1. b and c; 2. b and d; 3. b; 4. c; 5. b, c, and d; 6. a; 7. c; 8. a; 9. a through e; 10. c.
Getting Down to the Business
of Trading
79
CHAPTER 6
Brokers Buying Selling
The trading of listed options is federally regulated, a subject that is discussed in more detail in the next chapter. This means that you must open your stock or futures accounts through licensed brokerage firms. Do you go to the mountain, or do let it come to you? One of the potential dangers is waiting for a broker to come to you rather than initiating the meeting yourself. I say this because there are far too many aggressive options brokers who are more than willing to sell you options that sound super but have as much chance of getting into the money as Congress does of balancing the federal budget. You are ahead of the game if you are the aggressor—
researching firms, interviewing brokers, and finding a good brokerage firm that suits your needs and that you have confidence in.
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Do you go with a full-service brokerage firm, like Merrill Lynch, or a dis- count broker, like Scottrade? In the Financial World Village of the Internet, you can open an online account without any direct contact with a broker. Is this good or bad? The answer is very personal and depends on (1) whether you need or want direct contact with a broker to advise and educate you, (2) the honesty and quality of the broker, and (3) what exactly you need from a brokerage firm besides basic clearing and accounting. Do you want trade recommendations and research?
There is as big a difference in the amount of service you get from a brokerage firm as there is in the amount you pay in commissions. Full-service firms provide research, trading ideas, and shared experience. Discount brokers give you access to the research, but you have to know what you are looking for and how to analyze it. With discounters you usually have substantially lower costs and more direct control over your trading. To accept more control, you must be more educated in the theory and mechanics of trading.
If you are currently trading or investing with a firm, does your broker have any experience trading options? Will your broker honestly admit a lack of op- tions experience and risk losing you as a client or sharing commissions with an- other broker? Will your firm assign another broker to handle your option trades?
If your current broker is knowledgeable about options, this is a big plus, espe- cially if you like the firm and have confidence in the broker. But if your broker lacks an understanding of options and tries to talk you out of option trading, you should consider opening a second account somewhere else. Part of the basic training of brokers includes options, so brokers can talk as if they know a lot about options without having trading experience. The customer may not be able to tell if the broker is really qualified to trade options until it is too late, meaning that money has been lost. If you have any questions or doubts, call the office and ask to speak with the manager. The manager should give you some straight an- swers, but take notes or tape the conversations. If you have any problems later on, or if you think the manager has been less than forthright, you will be able to bring a complaint against the firm and may be able to get compensation if you suffer losses.
If you feel you have to open a new account at another brokerage firm, perhaps one that specializes in option trading, there may be some advantages. For example, opening another account makes is easier to keep your stock trading separate from your option trading, since reading and understanding brokerage statements is never easy. It is very important to set specific goals and be able to measure them, which might be simpler with a separate option account. However, using a second firm could be a problem if you plan to sell covered calls on stocks in your current ac- count. Additionally, you would not be able to use free cash and excess margin in