Question

1.) True or False. __________ The buyer of an option has the risk of having to meet margin calls.

2.) True or False. __________The option buyer’s financial risk is limited to the premium paid.

3.) True or False. __________An option seller must deposit margin to cover potential losses.

4.) What is an Option? Provide a definition. (3 points) ____________________________________________________________________________

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5.) What are the two (2) types of Options? Describe or define each briefly. (4 points)

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6.) What are the two (2) components of an option’s premium? In other words, what does an option premium consist of? (2 points)

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7.) During the life of an option, puts and calls are classified as being in one of three different categories based on whether it has intrinsic value or purely time value. This “classification” also refers to an option’s strike price relative to the underlying futures price. (3 points)

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8.) Time Value is the difference between an option’s total premium and the ____________________ value.

9.) List two (2) factors that affect the time value of an option. (2 points)

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10.) True or False. __________An option’s Time Value increases as it approaches expiration.

11.) True or False. __________At expiration, an option has zero (0) Time Value.

Answer 1

1) The buyer of an option has the risk of having to meet margin calls.

FALSE. The buyer of an option has the risk limited to the premium he/she has paid. Since the entire premium has been paid up front, there is no risk of having to meet margin calls.

2) The option buyer’s financial risk is limited to the premium paid.

TRUE. The option buyer’s financial risk is limited to the premium paid as explained in question 1.

3) An option seller must deposit margin to cover potential losses.

TRUE. An option seller's losses are undefined and as such they must deposit to cover the potential losses.

4) What is an Option?

An option gives a right to the buyer of the option to buy the underlying (call option) or a right to sell the underlying (put option) at a strike price by a specified time.