Question

True or False:

1. If you are short a put option that is exercised, and you are assigned, then you are required to sell the stock at the strike price.

2. An American option can be exercised only at the expiration date.

3. A call option gives the owner the right to purchase a fixed number of shares at a specified price, but no right to receive dividends paid during the life of the option.

4. A put option with a strike price of 45 is out of the money if the spot price of the underlying asset is 40.

5. Requiring a letter of credit or collateral is a way to protect oneself from counterparty credit risk.

Answer 1

1) Shorting a put option means we are having an OBLIGATION to buy the security at a particular price. Once if the other party exercises his right to sell we have no other option but we have to buy the security. It is to be understood that the other party will exercise his right only when he derives some profit by exercing the right, he will get profit only when the stock price in the market falls below the strike price.

Hence we can say that strike price is not same as the market price.

Therefore the given statement is FALSE as we have to buy stock strike price and sell it below strike price i.e market price

2) An American option can be exercised any time before expiration also but an European option can be exercised only at the expiration.

Hence the given statement is FALSE

3) It is to be noted that an OPTION is a derivate . Derivatives is contract the value of which is derived from an underlying asset. It will have minimum investment and at the end it will be settled only by changes in the value of underlying asset. Since an option is a derivate we cannot get the dividends from the derivative instead we get payoff i.e profit or loss moreover we are not the ower of the shares of that particular company.

Hence the given statement is TRUE

4) We know that a put option is a right to sell at a strike price. Here we have a right to sell at 45 but in the market the price is 40. Hence we can exercise our right we get a profit of 5 that means the put option is in money

Hence the given statement is FALSE

5) Counter party credit risk is the risk that the other party can default the payment. Inorder to protect ourself from such risk it is better to take a letter of credit or a collateral. If the other party makes default then we can either invoke the letter of credit or sell the collateral.

Hence the given statement is TRUE