shh - still testing!

Concerning the question posted yesterday (April 14), the answer is “b.” One of the primary appeals of purchasing options as a risk management tool is the fact that your potential loss is limited to the price paid for the option. In this case, if you pay 45 cents for a 440 corn put, your worst case scenario is a 45 cent loss. Bear in mind that prices can move in one of three directions; up, down or sideways. In two of three scenarios (up and sideways) you will suffer your worst-case scenario.

Let’s continue with our test with two more questions from my mid-term exam given yesterday. This first multiple choice question proved to be the most difficult question on the test, based on the large number of students who answered incorrectly.

Assume you pay a premium of 4 cents per pound for a live cattle call with a strike price of 75 cents. The underlying futures price is 73.5 cents. What is the time value of this option?

• a. 1.5 cents per pound
• b. 2.5 cents per pound
• c. 4.0 cents per pound
• d. there is no time value

My exam covered more than options. We spent several class sessions on the topic of spreads and spread trading. Here is a test question on the topic of spreading.

To simultaneously buy July wheat and sell July corn futures is an example of a…

• a. intercommodity spread
• b. cross-hedge
• c. bear spread
• d. interdelivery spread