Level 2 — RecallOptions Basics

Options Basics

⏱ 30 minutes40 marksprintable — key stays hidden on paper

Difficulty Level: 2 (Recall — definitions, standard problems, short derivations) Time Limit: 30 minutes Total Marks: 40

Section A — Definitions & Concepts

Q1. Define a call option and a put option. State one right that each grants to the buyer. (4 marks)

Q2. Explain the following three terms in one line each: strike price, premium, expiry. (3 marks)

Q3. State the difference between European-style and American-style options with respect to exercise. (3 marks)

Q4. Distinguish between exercise and assignment in options trading. (3 marks)

Section B — Moneyness & Value

Q5. For a stock trading at spot price $S = 100$ , classify the following as ITM, ATM, or OTM: (4 marks) (a) Call with strike $95$ (b) Call with strike $105$ (c) Put with strike $110$ (d) Put with strike $100$

Q6. A call option has strike $K = 250$ , the underlying trades at $S = 270$ , and the premium is $28$ . Compute the intrinsic value and the time value of this option. (4 marks)

Q7. A put option has strike $K = 500$ , the underlying trades at $S = 520$ , and the premium is $6$ . Compute the intrinsic value and the time value. Comment on its moneyness. (4 marks)

Section C — Payoffs & Breakeven

Q8. A trader buys a call option with strike $K = 1000$ and pays a premium of $30$ . (5 marks) (a) Write the breakeven price. (2) (b) Compute the buyer's profit/loss if the underlying expires at $1050$ . (2) (c) State the maximum loss for the buyer. (1)

Q9. State the maximum profit and maximum loss for: (4 marks) (a) A call buyer (b) A call seller (naked)

Q10. Open interest data for an index shows total put OI = 48,00,000 and total call OI = 40,00,000. (6 marks) (a) Compute the Put-Call Ratio (PCR). (2) (b) State whether PCR > 1 is conventionally read as bullish or bearish sentiment. (2) (c) Define open interest in one line. (2)

Answer keyMark scheme & solutions

Q1. (4 marks)

Call option: a contract giving the buyer the right, but not the obligation, to buy the underlying at the strike price on/before expiry. (2)
Put option: a contract giving the buyer the right, but not the obligation, to sell the underlying at the strike price on/before expiry. (2) Why: Options confer rights (not obligations) to buyers; calls = buy, puts = sell.

Q2. (3 marks)

Strike price: the fixed price at which the option can be exercised. (1)
Premium: the price paid by the buyer to the seller to acquire the option. (1)
Expiry: the date on which the option contract lapses/settles. (1)

Q3. (3 marks)

European-style: can be exercised only at expiry. (1.5)
American-style: can be exercised any time up to and including expiry. (1.5)

Q4. (3 marks)

Exercise: action taken by the option buyer to invoke their right to buy/sell. (1.5)
Assignment: obligation imposed on the option seller to fulfil the contract when a buyer exercises. (1.5)

Q5. (4 marks — 1 each)

(a) Call K=95, S=100 → S>K → ITM
(b) Call K=105, S=100 → S<K → OTM
(c) Put K=110, S=100 → K>S → ITM
(d) Put K=100, S=100 → ATM Why: Call ITM when S>K; Put ITM when S<K; ATM when S≈K.

Q6. (4 marks)

Intrinsic value (call) $= \max(S-K,0) = \max(270-250,0) = 20$ . (2)
Time value $=$ premium $-$ intrinsic $= 28 - 20 = 8$ . (2)

Q7. (4 marks)

Intrinsic value (put) $= \max(K-S,0) = \max(500-520,0) = 0$ . (1.5)
Time value $=$ premium $-$ intrinsic $= 6 - 0 = 6$ . (1.5)
Moneyness: $K<S$ → OTM. (1)

Q8. (5 marks)

(a) Breakeven (long call) $= K + \text{premium} = 1000 + 30 = 1030$ . (2)
(b) Payoff $= \max(S-K,0) - \text{premium} = (1050-1000) - 30 = 50 - 30 = 20$ profit. (2)
(c) Maximum loss $=$ premium paid $= 30$ . (1)

Q9. (4 marks)

(a) Call buyer: max profit = unlimited; max loss = premium paid. (2)
(b) Naked call seller: max profit = premium received; max loss = unlimited. (2)

Q10. (6 marks)

(a) $\text{PCR} = \dfrac{\text{Put OI}}{\text{Call OI}} = \dfrac{4800000}{4000000} = 1.2$ . (2)
(b) PCR > 1 is conventionally read as bullish (high put OI often reflects put-writing / support). (Accept "contrarian bullish" reasoning.) (2)
(c) Open interest: the total number of outstanding (not-yet-closed) option contracts at a given time. (2)

[
  {"claim":"Q6 intrinsic=20, time value=8","code":"S=270;K=250;prem=28;intr=max(S-K,0);tv=prem-intr;result=(intr==20 and tv==8)"},
  {"claim":"Q7 put intrinsic=0, time value=6","code":"S=520;K=500;prem=6;intr=max(K-S,0);tv=prem-intr;result=(intr==0 and tv==6)"},
  {"claim":"Q8 breakeven=1030 and payoff at 1050 is 20","code":"K=1000;prem=30;be=K+prem;payoff=max(1050-K,0)-prem;result=(be==1030 and payoff==20)"},
  {"claim":"Q10 PCR=1.2","code":"pcr=Rational(4800000,4000000);result=(pcr==Rational(6,5))"}
]