Question

You want to buy 100 shares of XYZ stock, and you don't want to pay more than $20 per share for it. Which option strategy would be the least expensive?

Use letters in alphabetical order to select options

1. A Buy one XYZ 20 call for $2.

2. B Sell one XYZ 20 call for $4.

3. C Buy one XYZ 20 put for $1.

4. D Sell one XYZ 20 put for $3.

You want to set up a covered call position on 1,000 shares of XYZ stock. Your goal is to collect the greatest premium, and you don't mind being assigned. Which of these would you probably do if XYZ were trading for $40 per share?

Use letters in alphabetical order to select options

1. A Buy 10 calls on XYZ stock with a strike price of $25.

2. B Sell 10 calls on XYZ stock with a strike price of $30.

3. C Sell 10 calls on XYZ stock with a strike price of $45.

4. D Sell 10 puts on XYZ stock with a strike price of $50.

You sell to open ten ABC 40 puts for $2 each. What's the best thing that can happen now?

Use letters in alphabetical order to select options

1. A ABC stock stays at $40, and the puts expire worthless.

2. B ABC stock stays at $40, and you buy back the puts for a profit.

3. C ABC's price rises to $50, and you're assigned to buy the stock at $40 per share.

4. D ABC stock falls to $30, and you exercise the puts to sell the stock at $40 per share.

Answer 1

Solution:-

(1)

Option A: If I want to buy 100 shares of XYZ stock and don't want to pay more than $20 per share for XYZ, I would have to buy a call option which has a strike price of $20 or less. This would guarantee me an option to buy the stock at maximum $20. Therefore, this option is correct

Option B and C: Selling call option or buying put option dopesn't result in buying of shares and therefore, these two options are not correct

Option D: While selling a put option with strike price of $20 may also result in me acquiring the stock for $20 but it would only happen if the stock price falls below $20 and the option holder exercises his option. On the contrary, if the stock price goes above $20, the option would not be exercised by the option holder and I wouldn't be able to buy the stock. Therefore, this option is not correct

Hence, the correct option is option A.

(2)

A covered call option is where a person sells a call option and at the same time buys the underlying stock at the current strike price. This covers the risk of losing money on option trade if the stock price goes higher as the loss in the option position would be hedged by way of profit on stock position.

In the given case, the stock price is $40, therefore the premium on call option with strike price of $30 will be much higher than the premium of option with the strike price of $45. Hence, We would have to sell call options with strike price of $30 to earn the maximum premium possible.. Based on this, the correct option is option B.

(3)

Once we sell a put option, we have received the premium and our beest case scenario is that the option expires worthless so that it is not exercised by the option holder which would let us pocket the entire option premium that we received as profits. The option would expire worthless only if the stock price at expiry is equal to or higher than the strike price.

When the stock price at expiry is equal to or higher than the strike price the option simply expires and the option seller doesn't have to buyback the option (as suggested under option B). Also, if the price is higher than the strike price, the option holder wouldn't exercise the option (as suggested under option C) as it won't be profitable to do so.

Therefore, based on above, the correct option is option A.