Options quiz

I haven’t run a quiz in a long time, so let’s try another.



For your convenience, the questions are repeated below.
However, you must click on the button to have your reply tallied

1) True or False:

    Trading iron condors is almost free money. Just set it and forget it

2) You have $50,000 in your trading account. As a speculation, you bought 20 Jul 70 call options. The stock has not performed as you hoped, but it has been moving higher all week and today (expiration Friday) opened for trading @ $69.80. Which of the following are true:

    a) You own these options and thus, cannot be assigned an exercise notice. Nothing bad can happen to you

    b) You must do your best to sell the calls before the market closes for the day – just in case the stock closes above $70 per share

    c) You should enter a limit order to sell the options now. Then forget all about them

    d) You should enter a limit order to sell the options now. Then lower the asking price later in the day – as often as necessary

    e) It is a reasonable plan to go for a bonanza by not looking at the stock or option price all day – until well after the market closes. Maybe you’ll get lucky and the stock will close @$72 – or higher.


3) Out of the money put options on equities (stocks and indexes) tend to trade with a significantly higher implied volatility than do the out of the money call options. Which of these statement is true.

    a) This has been true since put options were first listed for trading at the CBOE

    b) This observation is known as volatility skew

    c) This observation is known as option kurtosis

    d) This is unreasonable, and this perplexing pricing will end soon

    e) This is true because huge and sudden declines occur more often than huge and sudden rallies


4) You are very excited about the prospects for a specific stock. You expect it to rise by 40% (from $40 to above $55) within two months, three at the most. You have had this feeling about other stocks in the past, and your track record is so-so. Six times the stock moved lower, but 4 times the stock moved nicely higher (but not as high as you anticipated).

Which of the follow represent sound trades? Which trade suits you? Which is the worst, in your opinion?

    a) Buy three-month calls. Strike price $55

    b) Buy three month calls, strike price $50

    c) Buy two-month calls. Strike price $40

    c) Sell two month puts; strike price $40

    d) Sell three-month, 35/40 put spread

    e) Buy front-month 40/45 call spread

    f) Buy three month, 40/45 call spread

Answers tomorrow

991

3 Responses to Options quiz

  1. Tyler Craig 06/20/2011 at 9:32 AM #

    Mark,

    I wanted to get your thoughts on the advantages to using weekly options versus monthlies. I recently wrote a post on selling ITM calls to hedge AAPL stock. With AAPL around $323 my suggestion was to sell July 310 calls for around $18.60. Someone questioned why I didn’t just sell the June 24th weekly 310 call instead. Since I’m a creature of habit I guess I’ve yet to fully incorporate Weeklys into my thought process. I wanted to share my list of differences between the two in this AAPL covered call example and see if you thought I was leaving anything relevant out:

    1. July monthly option initially offers more premium, hence more downside protection (On the other hand, I could sell 3 or 4 Weeklies in the same time frame so perhaps that’s not as strong an advantage).
    2. Selling weeklies will rack up more commission/slippage (which may not be a big deal).
    3. Selling weeklies offers more flexibility in modifying strikes more frequently as needed.

    I’m sure there are a few others, but I’m actually thinking one could make a compelling case for using the Weeklys over Monthlies for defensive covered calls

    • Mark D Wolfinger 06/20/2011 at 10:08 AM #

      Tyler,
      My reply is simple: Writing Weeklys offers greater annualized reward potential, but comes with greater risk. There is nothing wrong with taking more risk, but your correspondent probably sees only the greater premiums (again, on an annualized basis) and is unaware of the risk.

      Risks
      a) Stock tumbles and you don’t have enough downside protection
      b) Stock moves much higher and there is not enough time premium in the 310 strike. Moving strike higher means more downside risk.
      c) Risk management is far more difficult. Shorter-term options have much more negative gamma. If the plan is to do nothing and wait for expiration (extremely foolish, IMHO), then gamma is not an issue. But any intelligent risk management is far more difficult.

      Other thoughts:
      Commissions are a pretty small factor. If not, the trader is using the wrong broker.
      Slippage is a big problem in some options and not so important in others. Obviously a trader should use Weeklys ONLY if the trade executions are at acceptable levels.

      I don’t buy the flexibility argument. I prefer to change strikes (adjust the trade) when I deem it necessary. Not when expiration arrives.

      There is NO COMPELLING CASE for using Weeklys. There is more reward and more risk – and that decision is up to the individual trader.

      Thanks. Good question.

      • Tyler Craig 06/20/2011 at 10:22 AM #

        Thanks for your thoughts Mark. Insightful as always-