CFA Practice Question

There are 206 practice questions for this study session.

CFA Practice Question

If you exercise a put option prior to expiration ______

A. you are obligated to sell the asset underlying the option contract at the option strike price.
B. you must have been the writer of the option when it was created.
C. you will receive less than you would if you let the option run to maturity.
D. you have behaved in a rational manner if the market price exceeds the strike price.
E. you must own a European option.
Correct Answer: A

User Contributed Comments 11

User Comment
Iyal Obligated? not have a right to sell at strike price? explanation please anyone
examinee Once u have exercised the option then u are obligated. U have the option only till u have not exercised.
stefdunk an option becomes an obligation when exercised
dhiru I seem to vaguely remember having read an hypothesis that : it is always advantageous to hold an option to maturity as opposed to exercising it earlier for the loss of opportunity costs (can't seem to recollect the exact specifics) but answer C, closely sums it up. Any thoughts of what I might have confused myself with ?.
tanyak Dhiru - I think that has to do with the price of an European call option relative to an American call option...if you exercise an American option prior to maturity, you are losing out on the opportunity cost to earn cash payments on the underlying and also because the lower bound of a European call incorporates the extra gain because of time value of the European option.
omer123 Plus you can't exercise a Euro Option before Maturity.
bobert Dhiru, you are correct in what you remember. An American and European Put will have basically the same price until expiration due to the opportunity cost of selling. The key word in C is that it WILL. This is not necessarily true. There are a few instances where it is beneficial to exercise an American put rather than hold till expiration. I am a little foggy on the specifics, but I believe it has something to do with the cash flow of the stock for one thing, such as dividends. I cannot recall another circumstance, but I feel as if there is one.
StanleyMo For put option you have the obligation to sell the asset if the buyer exercise the buy option.
tschorsch It is almost always advantageous to sell the option as opposed to exercising it before maturity since the price of the option will always include some non-intrinsic value. An American option must be worth more than the profit made on the execution because there is the chance that it will be worth even more later. If the option is far enough in the money, it will move very closely with the underlying and the difference may be less than the transaction costs.
ankurwa10 option D seems to describe someone with a self destruct button, doesn't it? Why sell when the market price is higher. Why choose to exercise an option sell when you clearly would have got a higher price in the market. Am i missing something?
GBolt93 tschorsch gave the correct answer to dhiru's question. It's a matter or selling instead of exercising not holding to maturity instead of exercising.
You need to log in first to add your comment.