CHAPTER 19
Options

REVIEW QUESTIONS

19-1. A call option is a short-term option to buy a specified number of shares at a stated price within a specified time period. A right is a corporate-created option to purchase a stated number of shares at a specified price within a specified period of time (usually within a few months).

A warrant is a long-term option created by a corporation that allows the holder to purchase a stated number of shares at a specified price within a specified period of time (usually a few years).

It is important to remember that call options are created by investors (individuals or institutions), while warrants and rights are created by corporations.

19-2. (a) Strike (exercise) price – the per-share price at which the common stock may be purchased or sold.

(b) Naked option – a call option written without the stock being owned by the writer, or a put option written by a writer who is not short the stock.

(c) Premium – the price paid by the option buyer to the writer or seller of the option (the market price of the option).

(d) Out-of-the-money option – a call whose exercise price exceeds the current stock price, or a put whose exercise price is less than the current stock price.

19-3. Investors, both individuals and institutions, write puts and calls in an attempt to profit from their beliefs about the underlying stock's likely price performance. Writers earn the premiums paid by the buyers.

19-4. Clearing corporations play an important role in the options market. They guarantee the performance of the contracts, preventing potential problems with writers who must honour their obligations. They also facilitate the taking of an opposite (closing) position at any time by buyers or sellers.

19-5. Option prices almost always exceed intrinsic values. This excess, sometimes called the premium over parity, exists because buyers are willing to pay some price for potential future stock price movements.
19-6. Option prices almost always exceed intrinsic values. The difference reflecting the option's potential appreciation is typically referred to as the time value. Time obviously has a positive value for call options because the longer the time to expiration for a call option, the more chance it has to appreciate.

19-7. Investors writing calls often are seeking the income from the premium. Such a strategy can supplement the dividend income on stocks held.

The obligation of a call writer is to deliver the stock for the strike price if called upon to do so.

19-8. An index option is a call or put option on a stock market index. Stock index options enable investors to trade on general stock market movements in the same way that they can trade on individual stocks.

Stock index options available in Canada include options on the TSE 35, the TIPS 35, and the TIPS 100. Soon, there will be an option on the S&P/TSE 60 Index.

19-9. The major differences between a stock index option and a stock option is that buyers of index options receive cash from the seller upon exercise of the contract. Stock options, in contrast, require the actual delivery of the stock upon exercise.

19-10. Writing covered calls is basically a conservative strategy. The writer forgoes (Renuncia) possible price appreciation while knowing what the likely gains are, whether the stock is called or not.

For a naked ( not owned by the writer) call writer, the potential gain is limited, while the potential loss is large.

19-11. To say an option is worth more alive than dead refers to the fact that it never pays to exercise an American call option on a non-dividend-paying stock early. Consider the holder of such an option who is ready to close out the position. The holder has two choices: exercise the call or sell it. It can be shown that the proceeds (ingresos) from the sale of the option exceed the proceeds from the exercise of the option. Thus, the option should be continued by selling it rather than