Question: What is the primary advantage of buying a long call option compared to buying the underlying stock?
A) Unlimited downside risk
B) Lower upfront capital with limited risk
C) The option gains value only if the stock price decreases
D) You receive dividends from the underlying stock
Correct Answer: B) Lower upfront capital with limited risk
Explanation:
A long call option allows you to control the underlying stock without owning it outright. Instead of paying the full price of the stock, you pay a smaller premium for the option. If the stock price rises, the option provides leveraged gains.
Additionally, the risk is **limited** to the premium you paid for the option, unlike buying the stock where losses can be significant if the price drops. This combination of **lower cost** and **defined risk** makes long call options attractive.
– Option A: Incorrect, as long calls have limited downside risk (premium paid).
– Option C: Incorrect, since long calls profit when the stock price increases.
– Option D: Incorrect, because options do not provide dividends; only stockholders receive dividends.
Quiz Question 2: Understanding the Shape of a Long Call P/L Graph
Question: Which of the following best describes the shape of the P/L graph for a long call option at expiration?
A) A straight line sloping upwards from zero, starting at the strike price
B) A flat horizontal line below zero until the strike price, then a line sloping upwards
C) A U-shaped curve with the lowest point at the strike price
D) A line that starts above zero and slopes downward as the stock price increases
Correct Answer: B) A flat horizontal line below zero until the strike price, then a line sloping upwards
Explanation:
The P/L graph for a long call option has two distinct parts:
1. **For stock prices below the strike price**, the option expires worthless, and the maximum loss is limited to the premium paid. The P/L remains flat (horizontal) at **-premium** (e.g., -$10).
2. **For stock prices above the strike price**, the option gains intrinsic value. Every $1 increase in the stock price adds $1 to the option’s value, causing the P/L curve to slope upward at a 45° angle. At the strike price, the loss is exactly the premium paid, and the break-even point occurs at **strike price + premium**.
– Option A: Incorrect. The curve doesn’t start from zero; it starts from **-premium** and stays flat before rising.
– Option C: Incorrect. This describes a parabola, which is not the shape of a long call P/L graph.
– Option D: Incorrect. The P/L never slopes downward as the stock price increases. It slopes **upward** for stock prices above the strike.
– Option B: Correct. This accurately describes the two-part shape of the graph.
Quiz Question 3: Delta and the P/L Graph of a Long Call Option
Question: How does the delta of a long call option change as the stock price moves from far below the strike price to far above the strike price?
A) Delta starts at 0, increases to 0.5 at the strike price, and approaches 1 as the stock price rises further
B) Delta is always 1 regardless of the stock price
C) Delta is negative for stock prices below the strike price and becomes positive for prices above the strike price
D) Delta remains constant at 0.5 throughout
Correct Answer: A) Delta starts at 0, increases to 0.5 at the strike price, and approaches 1 as the stock price rises further
Explanation:
Delta describes how much the price of an option moves relative to a $1 move in the underlying stock. For a long call option, the behavior is as follows:
1. **Stock Price Far Below the Strike**: The option is deep out-of-the-money (OTM), so delta is close to 0 because the option is unlikely to be exercised.
2. **Stock Price Near the Strike**: As the stock price approaches the strike price, the option is “at-the-money” (ATM), and delta is approximately **0.5**. This means the option is equally likely to finish in or out of the money.
3. **Stock Price Far Above the Strike**: The option becomes deep in-the-money (ITM), and delta approaches **1** because the option behaves almost like the stock itself.
– Option A: Correct. This perfectly describes delta’s progression from 0 → 0.5 → 1.
– Option B: Incorrect. Delta is 1 only for deep ITM options, not for all stock prices.
– Option C: Incorrect. Delta is never negative for a long call option. Negative delta is for put options.
– Option D: Incorrect. Delta changes from 0 to 1 as the stock price rises; it is not constant.
Quiz Question 4: Theta and Its Impact on a Long Call Option
Question: How does the passage of time (theta decay) affect the P/L graph of a long call option before expiration?
A) The P/L graph shifts upward as time passes, regardless of stock price movement
B) The P/L graph shifts downward as time passes, especially for at-the-money (ATM) options
C) The P/L graph remains unchanged because theta does not affect the option’s value
D) The P/L graph shifts downward only if the option is in-the-money (ITM)
Correct Answer: B) The P/L graph shifts downward as time passes, especially for at-the-money (ATM) options
Explanation:
Theta (time decay) reduces the extrinsic value of an option over time. Here’s how it impacts the P/L graph:
1. **At-the-Money (ATM) Options**: These options have the most extrinsic value, so they experience the highest theta decay. The P/L graph shifts downward over time, making it harder to break even.
2. **In-the-Money (ITM) Options**: Since ITM options have more intrinsic value and less extrinsic value, theta decay has less of an effect. The P/L curve shifts downward only slightly.
3. **Out-of-the-Money (OTM) Options**: OTM options lose value rapidly as they approach expiration. Since they have no intrinsic value, their extrinsic value decays to zero, causing a steep downward shift in the P/L curve.
– Option A: Incorrect. The P/L graph does **not shift upward** due to time decay. Time decay hurts option buyers, not helps them.
– Option B: Correct. Time decay causes a downward shift in the P/L graph, with the steepest effect for ATM options.
– Option C: Incorrect. Theta decay **does affect** the value of options, especially ATM options.
– Option D: Incorrect. While ITM options are affected by theta decay, the impact is greater for ATM options.
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Quiz Question 5: Reading the Intrinsic Value on a Long Call Option Graph
Question: On a graph showing the intrinsic value of a long call option, which part of the x-axis represents the region where the option has zero intrinsic value?
A) The region to the left of the strike price
B) The region to the right of the strike price
C) The entire x-axis
D) The point where the stock price equals the strike price
Correct Answer: A) The region to the left of the strike price
Explanation:
Intrinsic value for a long call option is the amount by which the stock price exceeds the strike price. Here’s how it works:
1. **Stock Price < Strike Price**: When the stock price is below the strike price (left side of the strike on the x-axis), the option has no intrinsic value because it would not be exercised. The option is "out-of-the-money" (OTM) in this region.
2. **Stock Price = Strike Price**: At the exact strike price, the intrinsic value is zero. This is the point where the option moves from OTM to ITM, but it has no immediate value.
3. **Stock Price > Strike Price**: Once the stock price moves above the strike price (right side of the strike on the x-axis), the option has intrinsic value. The intrinsic value is calculated as **stock price – strike price**. For example, if the strike price is \$100 and the stock price is \$110, the intrinsic value is **\$10**.
– Option A: Correct. The region to the left of the strike price has zero intrinsic value because the stock price is below the strike price.
– Option B: Incorrect. The region to the right of the strike price has **positive intrinsic value**, not zero.
– Option C: Incorrect. Only the region to the left of the strike has zero intrinsic value, not the entire x-axis.
– Option D: Incorrect. At the exact strike price, the option’s intrinsic value is zero, but this is only a single point, not a “region.”
