Call Option

A call option whose strike price sits above the current market price of the underlying stock trades at a premium of 2. That premium consists of

1. A.intrinsic value of 2 and no time value at all.Wrong. Immediate exercise would cost more than buying the stock outright, so nothing is intrinsic here.
2. B.time value of 2 and no intrinsic value at all.Correct. With the strike above the market, everything the buyer is paying for lies in the future.
3. C.intrinsic value and time value in roughly equal proportions.Wrong. That split requires the option to be in the money, which a strike above the market is not.
4. D.neither, since an out-of-the-money option cannot command a premium.Wrong. The chance of a move before expiration is exactly what buyers are paying for.

Why: An option premium always divides into intrinsic value, which is what the holder would gain by exercising immediately, and time value, which is what the market charges for the possibility of a favourable move before expiration. A call whose strike lies above the market price would produce nothing on immediate exercise, so its intrinsic value is zero and the whole premium is time value. That is why an out-of-the-money option loses value steadily if the underlying does not move. Once the stock rose above the strike, intrinsic value would appear and the premium would split between the two components.

A client holds a long call option and the underlying stock trades at essentially the same price for several weeks. Over that period the premium on his option will generally

1. A.decline, because time value erodes as the expiration date draws nearer.Correct. Time is an input in its own right, and it is consumed whether or not the stock moves.
2. B.remain unchanged, since the price of the underlying stock has not moved.Wrong. The premium has two components, and the passage of time consumes one of them regardless.
3. C.rise, because a longer record of stability makes the option safer to hold.Wrong. Stability reduces the likelihood of the very move the option needs in order to pay.
4. D.decline, but only where the option is currently in the money.Wrong. An out-of-the-money option is nothing but time value, so it decays fastest of all.

Why: An option is a wasting asset because one of the two components of its price is the time remaining before expiration. Holding the underlying still, the passage of time removes optionality without replacing it with anything, so the premium erodes and the erosion accelerates as expiration approaches. This is why a long option position needs the underlying to move, and to move soon enough, before it can be profitable. A rise in implied volatility could offset the decay for a time, but nothing in a period of price stability supplies one.

A court appoints Delphine Marchbank conservator of the estate of her father, who has been found unable to manage his own affairs. She presents the firm with the court order, which authorises her to "collect, preserve and invest the assets of the estate in fixed income obligations and investment grade securities." She then asks the agent to sell the father's bond portfolio and buy call options on a volatile technology stock. What governs whether the agent may accept the order?

1. A.The conservator's own judgment, since a court-appointed fiduciary is presumed to act in the ward's best interest.Good faith does not enlarge authority. The fiduciary may act only within the powers the court actually conferred.
2. B.The firm's general suitability obligations, which permit the trade if options are suitable for the estate's objectives.Suitability is a separate question that is never reached, because the transaction is outside the conservator's granted authority.
3. C.State law governing prudent investments, which overrides any narrower language in the appointment.Prudent investor principles operate within the appointment, not over it. The order's express limits control.
4. D.The terms of the court order, which authorise only fixed income and investment grade securities, so the agent must refuse.Correct. A court-appointed fiduciary has exactly the powers the order grants, and buying call options falls outside them.

Why: The scope of a conservator's or guardian's authority is fixed by the COURT ORDER that created it, and the firm must read that order and act within it. A fiduciary appointed by a court has no general power over the estate; she has the specific powers the court granted, and the firm is on notice of the limits because it has the order in hand. Delphine's appointment authorises investment in fixed income obligations and investment grade securities. Buying call options on a volatile technology stock falls outside that authorisation, so the agent must refuse the order regardless of Delphine's good faith or her view of what would benefit her father. Where a fiduciary wants to act beyond the order, the route is back to the court for expanded authority.

Ines Corradine holds two contracts. The first gives her the right, for six months, to buy a parcel of undeveloped land at a stated price. The second gives her the right, for six months, to buy 500 shares of a listed company at a stated price. Under the Uniform Securities Act, which is a security?

1. A.Both options, because each is a right to buy an asset at a set price.Incorrect. Only the option on a security is within the definition.
2. B.The option on the land only, because an option is itself a contract of value.Incorrect. An option on real property is not an option on a security.
3. C.The option on the 500 shares only.Correct. The definition covers options and privileges on a security.
4. D.Neither option, because an option is a right to acquire property rather than property itself.Incorrect. Options on securities are expressly named in the definition.

Why: The definition includes a put, call, straddle, option or privilege on any security. An option on real property is not on a security and is therefore outside the definition; the option on the shares is itself a security, quite apart from the shares underlying it.