MULTIPLE-CHOICE QUESTIONS WITH ANSWERS RELATED TO OPTION VALUATION: GENERAL PRINCIPLES

What is an option in financial markets?

A. A type of stock
B. A derivative contract
C. A bond
D. A form of currency
Answer: B. A derivative contract

Which model is most commonly used to value European options?

A. Black-Scholes model
B. Binomial model
C. Monte Carlo simulation
D. CAPM model
Answer: A. Black-Scholes model

What does the term ‘in-the-money’ refer to in options trading?

A. An option that has no intrinsic value
B. An option that has intrinsic value
C. An option that has expired
D. An option with the same strike price as the underlying asset’s current price
Answer: B. An option that has intrinsic value

Which of the following is NOT a factor affecting the value of an option?

A. Strike price
B. Expiry date
C. Interest rates
D. Dividend payout date of a bond
Answer: D. Dividend payout date of a bond

What is the ‘strike price’ in an options contract?

A. The price at which the option can be bought or sold
B. The current market price of the underlying asset
C. The price at which the option was initially bought
D. The price at which the underlying asset can be bought or sold when the option is exercised
Answer: D. The price at which the underlying asset can be bought or sold when the option is exercised

Which term describes the time value component of an option’s price?

A. Intrinsic value
B. Extrinsic value
C. Real value
D. Nominal value
Answer: B. Extrinsic value

What does ‘volatility’ measure in the context of option valuation?

A. The frequency of trades
B. The price movement of the underlying asset
C. The interest rate fluctuations
D. The dividends paid by the underlying asset
Answer: B. The price movement of the underlying asset

Which of the following best describes a ‘call option’?

A. An option to sell a stock at a specified price
B. An option to buy a stock at a specified price
C. An option to hold a stock without purchasing it
D. An option to trade a stock at the current market price
Answer: B. An option to buy a stock at a specified price

What is the main difference between American and European options?

A. The underlying assets they cover
B. The geographic location of the exchanges where they are traded
C. The ability to exercise the option before expiration
D. The currency in which they are denominated
Answer: C. The ability to exercise the option before expiration

Which Greek letter represents the rate of change of an option’s price relative to the price change of the underlying asset?

A. Delta
B. Gamma
C. Theta
D. Vega
Answer: A. Delta

What is the purpose of using the Black-Scholes model in option valuation?

A. To calculate the intrinsic value of an option
B. To estimate the fair price of an option
C. To predict future stock prices
D. To assess the risk associated with an option
Answer: B. To estimate the fair price of an option

Which factor is NOT part of the Black-Scholes option pricing formula?

A. Current price of the underlying asset
B. Strike price
C. Expiry date
D. Past dividend payouts
Answer: D. Past dividend payouts

What is meant by ‘time decay’ in options trading?

A. The increase in an option’s value as it approaches expiration
B. The decrease in an option’s value as it approaches expiration
C. The stability of an option’s value over time
D. The change in an option’s strike price over time
Answer: B. The decrease in an option’s value as it approaches expiration

What is a ‘put option’?

A. An option to buy a stock at a specified price
B. An option to sell a stock at a specified price
C. An option to convert a stock into bonds
D. An option to hold a stock without purchasing it
Answer: B. An option to sell a stock at a specified price

What is ‘implied volatility’ in the context of options?

A. The actual historical volatility of the underlying asset
B. The market’s forecast of a likely movement in the underlying asset’s price
C. The volatility of an option’s price
D. The difference between an option’s strike price and the underlying asset’s price
Answer: B. The market’s forecast of a likely movement in the underlying asset’s price

Which of the following best describes an ‘at-the-money’ option?

A. An option where the strike price is equal to the market price of the underlying asset
B. An option with no time value
C. An option with no intrinsic value
D. An option that cannot be exercised
Answer: A. An option where the strike price is equal to the market price of the underlying asset

What is the term for the price paid for an option?

A. Margin
B. Premium
C. Interest
D. Fee
Answer: B. Premium

Which term represents the sensitivity of an option’s price to changes in volatility?

A. Delta
B. Gamma
C. Theta
D. Vega
Answer: D. Vega

Which of the following is NOT true about options?

A. They are considered derivatives
B. They can be used for hedging
C. They always result in a profit
D. They have an expiration date
Answer: C. They always result in a profit

What is ‘intrinsic value’ in the context of options?

A. The difference between the strike price and the current price of the underlying asset
B. The total value of the option
C. The time value of the option
D. The historical volatility of the option
Answer: A. The difference between the strike price and the current price of the underlying asset

What does the term ‘exercise’ refer to in options trading?

A. Buying the option
B. Selling the option
C. Buying or selling the underlying asset as per the terms of the option contract
D. Holding the option until expiration
Answer: C. Buying or selling the underlying asset as per the terms of the option contract

What is the primary benefit of using options for hedging purposes?

A. They offer unlimited profits
B. They limit potential losses
C. They have no cost
D. They guarantee returns
Answer: B. They limit potential losses

Which factor does NOT directly influence the premium of an option?

A. Volatility of the underlying asset
B. Time to expiration
C. Dividend payout of the underlying asset
D. Market interest rates
Answer: C. Dividend payout of the underlying asset

In the context of options, what does ‘delta’ measure?

A. The rate of change of the option’s price relative to the price change of the underlying asset
B. The time decay of the option
C. The volatility of the option
D. The intrinsic value of the option
Answer: A. The rate of change of the option’s price relative to the price change of the underlying asset

What is ‘theta’ in option pricing?

A. The sensitivity of the option price to changes in the underlying asset’s price
B. The sensitivity of the option price to changes in volatility
C. The sensitivity of the option price to the passage of time
D. The sensitivity of the option price to changes in interest rates
Answer: C. The sensitivity of the option price to the passage of time

Which of the following best describes a ‘put option’?

A. An option to buy the underlying asset at a specified price
B. An option to sell the underlying asset at a specified price
C. An option to hold the underlying asset without purchasing it
D. An option to trade the underlying asset at the current market price
Answer: B. An option to sell the underlying asset at a specified price

What is the purpose of a ‘protective put’ strategy?

A. To speculate on the price movement of the underlying asset
B. To generate income from premiums
C. To hedge against a potential decline in the value of the underlying asset
D. To maximize potential profit from an upward movement in the underlying asset
Answer: C. To hedge against a potential decline in the value of the underlying asset

What does ‘gamma’ measure in option pricing?

A. The sensitivity of delta to changes in the underlying asset’s price
B. The time decay of the option
C. The intrinsic value of the option
D. The overall risk of the option
Answer: A. The sensitivity of delta to changes in the underlying asset’s price

Which option strategy involves holding both a call and a put option with the same strike price and expiration date?

A. Straddle
B. Strangle
C. Spread
D. Collar
Answer: A. Straddle

What is ‘volatility skew’?

A. The difference in implied volatility for options with different strike prices
B. The difference in actual and implied volatility
C. The change in volatility over time
D. The uniformity of volatility across all options
Answer: A. The difference in implied volatility for options with different strike prices

Which of the following is true about American options?

A. They can only be exercised at expiration
B. They can be exercised at any time before expiration
C. They have no intrinsic value
D. They are not affected by interest rates
Answer: B. They can be exercised at any time before expiration

Which factor is considered when calculating the intrinsic value of a call option?

A. Time to expiration
B. Volatility of the underlying asset
C. Strike price and current price of the underlying asset
D. Interest rates
Answer: C. Strike price and current price of the underlying asset

What is ‘rho’ in the context of options?

A. The rate of change of an option’s price relative to changes in the interest rate
B. The rate of change of an option’s price relative to the price change of the underlying asset
C. The rate of change of an option’s price relative to changes in volatility
D. The rate of change of an option’s price relative to the passage of time
Answer: A. The rate of change of an option’s price relative to changes in the interest rate

Which strategy involves writing a call option while owning the equivalent amount of the underlying asset?

A. Naked call
B. Covered call
C. Long call
D. Protective call
Answer: B. Covered call

What is meant by ‘assignment’ in options trading?

A. The obligation of the option holder to buy the underlying asset
B. The obligation of the option writer to fulfill the terms of the option contract
C. The transfer of the option to another party
D. The cancellation of the option contract
Answer: B. The obligation of the option writer to fulfill the terms of the option contract

What is ‘implied volatility’?

A. The historical volatility of the underlying asset
B. The expected volatility of the underlying asset derived from the option’s price
C. The actual price movement of the option
D. The difference between the strike price and the underlying asset’s price
Answer: B. The expected volatility of the underlying asset derived from the option’s price

Which of the following is a bullish options strategy?

A. Long put
B. Covered call
C. Protective put
D. Long call
Answer: D. Long call

What is a ‘bull spread’?

A. An option strategy that profits from a rising market
B. An option strategy that profits from a falling market
C. An option strategy that profits from market stability
D. An option strategy that profits from high volatility
Answer: A. An option strategy that profits from a rising market

What is a ‘bear spread’?

A. An option strategy that profits from a rising market
B. An option strategy that profits from a falling market
C. An option strategy that profits from market stability
D. An option strategy that profits from low volatility
Answer: B. An option strategy that profits from a falling market

What is the ‘breakeven point’ for a call option?

A. The strike price plus the premium paid
B. The strike price minus the premium paid
C. The current market price of the underlying asset
D. The highest price of the underlying asset
Answer: A. The strike price plus the premium paid

Which of the following is a protective strategy for an investor holding a stock position?

A. Writing a call option
B. Buying a put option
C. Selling a put option
D. Buying a call option
Answer: B. Buying a put option

What is a ‘long straddle’ strategy?

A. Buying a call option and selling a put option with the same strike price and expiration date
B. Buying both a call option and a put option with the same strike price and expiration date
C. Selling both a call option and a put option with the same strike price and expiration date
D. Holding the underlying asset without any options
Answer: B. Buying both a call option and a put option with the same strike price and expiration date

Which option strategy is used to benefit from a decrease in volatility?

A. Long straddle
B. Short straddle
C. Long call
D. Long put
Answer: B. Short straddle

What does ‘delta hedging’ aim to achieve?

A. To maximize the potential profit of an options position
B. To reduce the risk associated with price movements of the underlying asset
C. To increase the time value of an options position
D. To speculate on the volatility of the underlying asset
Answer: B. To reduce the risk associated with price movements of the underlying asset

What is a ‘naked call’ option strategy?

A. Writing a call option without owning the underlying asset
B. Writing a call option while owning the underlying asset
C. Buying a call option without owning the underlying asset
D. Buying a call option while owning the underlying asset
Answer: A. Writing a call option without owning the underlying asset

What is the primary risk of writing a naked call option?

A. Limited profit potential
B. Unlimited loss potential
C. High premium costs
D. Time decay of the option
Answer: B. Unlimited loss potential

What is an ‘iron condor’ strategy in options trading?

A. Buying and selling call options with the same expiration date but different strike prices
B. Buying and selling put options with the same expiration date but different strike prices
C. Combining a bull put spread and a bear call spread with the same expiration date
D. Buying both a call and a put option with the same strike price and expiration date
Answer: C. Combining a bull put spread and a bear call spread with the same expiration date

What is a ‘synthetic long stock’ position in options trading?

A. Buying a call option and selling a put option with the same strike price and expiration date
B. Buying both a call and a put option with the same strike price and expiration date
C. Selling both a call and a put option with the same strike price and expiration date
D. Buying a put option and selling a call option with the same strike price and expiration date
Answer: A. Buying a call option and selling a put option with the same strike price and expiration date

What is the ‘VIX’?

A. The volatility index that measures the market’s expectation of volatility
B. The volume index of options traded in a market
C. The value index of options
D. The index of the most traded options
Answer: A. The volatility index that measures the market’s expectation of volatility

What is meant by ‘delta-neutral’ in options trading?

A. An options position with zero delta
B. An options position that is not affected by changes in the underlying asset’s price
C. An options position that profits equally from upward and downward movements
D. An options position that only profits from changes in volatility
Answer: B. An options position that is not affected by changes in the underlying asset’s price