Options & Derivatives Interview Questions - Market Risk Roles

I have been asked such questions over and over and I want you atleast to prepare such interview questions and go confidently in the Interviews.

Q1.  Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until maturity. Under what circumstances will the holder of the option make a profit? Under what circumstances will the option be exercised? Draw a diagram illustrating how the profit from a long position in the option depends on the stock price at maturity of the option.

Ignoring the time value of money, the holder of the option will make a profit if the stock price at maturity of the option is greater than $105. This is because the payoff to the holder of the option is, in these circumstances, greater than the $5 paid for the option. The option will be exercised if the stock price at maturity is greater than $100. Note that if the stock price is between $100 and $105 the option is exercised, but the holder of the option takes a loss overall. The profit from a long position is as shown

Q2.  An investor buys a European put on a share for $3. The stock price is $42 and the strike price is $40. Under what circumstances does the investor make a profit? Under what circumstances will the option be exercised? Draw a diagram showing the variation of the investor’s profit with the stock price at the maturity of the option.

The investor makes a profit if the price of the stock on the expiration date is less than $37. In these circumstances the gain from exercising the option is greater than $3. The option will be exercised if the stock price is less than $40 at the maturity of the option. The variation of the investor’s profit with the stock price

Q3.  An investor sells a European call on a share for $4. The stock price is $47 and the strike price is $50. Under what circumstances does the investor make a profit? Under what circumstances will the option be exercised? Draw a diagram showing the variation of the investor’s profit with the stock price at the maturity of the option.

The investor makes a profit if the price of the stock is below $54 on the expiration date. If the stock price is below $50, the option will not be exercised, and the investor makes a profit of $4. If the stock price is between $50 and $54, the option is exercised and the investor makes a profit between $0 and $4. The variation of the investor’s profit with the stock price is

Q4.  Suppose that a European put option to sell a share for $60 costs $8 and is held until maturity. Under what circumstances will the seller of the option (the party with the short position) make a profit? Under what circumstances will the option be exercised? Draw a diagram illustrating how the profit from a short position in the option depends on the stock price at maturity of the option.

Ignoring the time value of money, the seller of the option will make a profit if the stock price at maturity is greater than $52.00. This is because the cost to the seller of the option is in these circumstances less than the price received for the option. The option will be exercised if the stock price at maturity is less than $60.00. Note that if the stock price is between $52.00 and $60.00 the seller of the option makes a profit even though the option is exercised. The profit from the short position is as shown

Key Points to Remember:

Make sure to think about the following:

Long Call = Investors think the Market will go up.

Short Call = Investors think the Market will go down.

Long Put = Investors think the Market will go down.

Short Put = Investors think the Market will go up.

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