Chapter 10 - Options on Futures Contracts

If an option’s trader expect that interest rates will decrease they should buy Eurodollar Put options.

• True

• False

• EXPLANATION

  If interest rates decrease, prices would rise, therefore the trader should buy Call options, not Puts. Remember that Eurodollars represent US Dollars outside of the US not to be confused with the Euro, which is the uniform foreign currency of 12 European countries.

If long Put options are exercised, the buyer of the put will be assigned a Short Future.

• True

• False

• EXPLANATION

  If a long Put option is exercised, then the holder or person who is long the Put will be assigned a short position in the futures.

If the seller of a call option receives an exercise notice, they would be assigned a Long position in the futures.

• True

• False

• EXPLANATION

  When exercised the buyer of a Call would be assigned a Long position in the futures and the seller of the Call would be assigned a Short position in the futures.

One of your clients "Solid Investment Company", a securities dealer, has a large position in long-term U.S. Treasury Bonds maturing in 2023. The company wants to hedge these bonds by using options on bond futures. How should the dealer hedge?

• Short calls.

• Short puts.

• Long calls.

• Long puts.

• EXPLANATION

  This investor would be looking for downside protection – the best downside protection with options is to buy a put.

If an option on an underlying futures contract is in-the-money, the premium for the option will move dollar for dollar with the movement of the underlying future’s price.

• True

• False

• EXPLANATION

  
  

  The measure of an option premium’s rate of change given a change in the price of the underlying is called its “delta”. The premium’s “delta” here would be +1 or +100%. i.e. the premium changes dollar for dollar with the change in the price of the underlying.

The value of a purchased stock portfolio would be best protected or hedged by which of the following?

• An appropriate hedge would be long S&P puts.

• An appropriate hedge would be long S&P calls.

• An appropriate hedge would be short S&P futures.

• An appropriate hedge would be both answers A and C.

• EXPLANATION

  
  

  A "purchased" stock portfolio implies that the holder of the portfolio is long in the stocks. In order to hedge against a long equity portfolio, the individual would be best served by selling short S&P futures (in case of downward market trends), and/or buying S&P puts (in case of downward market trends.

In order to hedge using options on T-Bond futures, a person who thinks interest rates will increase should:

• Buy calls.

• Write puts.

• Either buy puts or write calls.

• Buy calls and write puts.

• EXPLANATION

  If interest rates increase then prices would decrease and if prices are going to decrease investors should write calls or buy puts.

If long Call options are exercised the buyer of the call will be assigned a Long Future.

• True

• False

• EXPLANATION

  If a long call option on futures is exercised then the holder or person who is long the call will be assigned a long position in the futures.

A synthetic long put is an equivalent combination of a short futures contract and a long call option.

• True

• False

• EXPLANATION

  
  

  A synthetic long put has the same payoff characteristics as a regular long put. They are both bearish. In the synthetic, the primary position is the short futures contract. The long call is a protective position.

The amount the option price premium changes relative to the percentage change in price in the underlying future is called:

• the Standard Deviation.

• the Coefficient of Variation.

• the volatility factor.

• the Delta

• EXPLANATION

  The question itself gives the correct definition of an options delta.