Course outline
Module 1
Module 1: Options Basics and Terminology
Options Basics and Terminology
Knowledge check
Q1. What does a call option give the buyer?
- A. The obligation to buy the underlying asset at the strike price
- B. The right, but not the obligation, to buy the underlying asset at the strike price ✓
- C. The right to sell the underlying asset at the strike price
- D. The obligation to sell the underlying asset at the market price
Why: A call option gives the buyer the right, but not the obligation, to purchase the underlying asset at the strike price before or at expiration. The seller (writer) has the obligation to sell if the buyer exercises.
Q2. What is the strike price of an option?
- A. The price paid to purchase the option contract
- B. The current market price of the underlying asset
- C. The predetermined price at which the underlying asset can be bought or sold ✓
- D. The date on which the option expires
Why: The strike price, also called the exercise price, is the fixed price specified in the contract at which the holder can buy (call) or sell (put) the underlying asset.
Q3. What is the premium in an options contract?
- A. The profit earned when an option is exercised
- B. The commission charged by the broker
- C. The price the buyer pays the seller to acquire the option ✓
- D. The difference between the strike price and the expiration price
Why: The premium is the upfront price the option buyer pays to the seller for the rights granted by the contract. It is kept by the seller regardless of whether the option is exercised.
Q4. What does it mean when an option is 'in the money' for a call option?
- A. The market price of the underlying asset is below the strike price
- B. The option has expired worthless
- C. The market price of the underlying asset is above the strike price ✓
- D. The option premium is equal to the strike price
Why: A call option is in the money when the underlying asset's market price exceeds the strike price, meaning exercising the option would provide an immediate value advantage.
Q5. What is the expiration date of an option?
- A. The date the option was first issued
- B. The last date on which the option holder can exercise the contract ✓
- C. The date the premium must be paid
- D. The date the underlying asset pays a dividend
Why: The expiration date is the final day on which the option can be exercised. After this date, the option becomes void and has no remaining value.
Module 2
Module 2: Calls, Puts, and Payoff Diagrams
Calls, Puts, and Payoff Diagrams
Knowledge check
Q1. What right does the buyer of a call option receive?
- A. The right to sell the underlying asset at the strike price before expiration
- B. The right to buy the underlying asset at the strike price before or at expiration ✓
- C. The obligation to buy the underlying asset at the strike price at expiration
- D. The right to receive dividends from the underlying asset
Why: A call option gives the buyer the right, but not the obligation, to buy the underlying asset at the strike price on or before the expiration date. Selling the asset describes a put option, not a call.
Q2. An investor buys a put option with a strike price of $50 for a premium of $3. What is the breakeven price at expiration?
- A. $53
- B. $47 ✓
- C. $50
- D. $56
Why: A put buyer profits when the underlying price falls below the strike. Breakeven equals strike minus premium: $50 - $3 = $47. Below $47, the put is profitable at expiration.
Q3. Which statement describes the maximum loss for a call option buyer?
- A. Unlimited, because the stock price can rise without limit
- B. Equal to the strike price
- C. Equal to the premium paid for the option ✓
- D. Equal to the difference between the stock price and the strike price
Why: The most a call buyer can lose is the premium paid. If the option expires worthless, the buyer simply lets it expire, losing only the premium, while the potential gain remains theoretically unlimited.
Q4. On a payoff diagram at expiration, what does the profit line of a long call look like?
- A. A horizontal line at zero for all stock prices
- B. A downward-sloping line starting from the strike price
- C. A flat line at the negative premium, then rising upward after the breakeven point ✓
- D. A V-shaped line centered on the strike price
Why: A long call loses the premium (a flat line at negative premium) when the stock is at or below the strike. Above the strike, profit rises with the stock price, crossing zero at the breakeven (strike plus premium).
Q5. A trader sells a call option with a $60 strike and receives a $4 premium. If the stock finishes at $68 at expiration, what is the trader's profit or loss per share?
- A. $4 profit
- B. $4 loss ✓
- C. $8 loss
- D. $12 loss
Why: The call is exercised against the seller, who must deliver shares worth $68 for $60, a $8 loss. The $4 premium received offsets part of this, leaving a net loss of $4 per share.
Module 3
Module 3: Pricing Fundamentals and Intrinsic Value
Pricing Fundamentals and Intrinsic Value
Knowledge check
Q1. What is the intrinsic value of a call option?
- A. The difference between the strike price and the current market price of the underlying asset, if the strike is higher than the market price
- B. The greater of zero or the difference between the underlying asset's current price and the option's strike price ✓
- C. The total premium paid for the option
- D. The time remaining until the option's expiration date
Why: A call option's intrinsic value equals max(0, S - K), where S is the underlying price and K is the strike price. It is never negative, because the holder can simply let the option expire worthless instead of exercising it.
Q2. A put option has a strike price of $50 and the underlying stock trades at $42. What is the put's intrinsic value?
- A. $0
- B. $8 ✓
- C. $42
- D. $92
Why: A put's intrinsic value is max(0, K - S). Here, $50 - $42 = $8. The put is 'in the money' because the holder could sell the stock at $50 when it trades at $42.
Q3. Which statement best describes an out-of-the-money option?
- A. An option whose intrinsic value is greater than its premium
- B. An option that has no intrinsic value at its current underlying price ✓
- C. An option that has already been exercised
- D. An option with an expiration date more than one year away
Why: An out-of-the-money option would be unprofitable to exercise right now. A call is out of the money when the stock is below the strike, and a put is out of the money when the stock is above the strike, so intrinsic value is zero.
Q4. An investor owns a call option with a strike price of $30 on a stock currently trading at $35, and the option premium is $7. What is the time value of the option?
- A. $2 ✓
- B. $5
- C. $7
- D. $12
Why: Intrinsic value is $35 - $30 = $5. Time value is the premium minus intrinsic value: $7 - $5 = $2. Time value reflects the possibility that the option becomes more valuable before expiration.
Q5. Which factor generally causes an option's time value to decrease as expiration approaches?
- A. Increasing implied volatility
- B. Time decay, since less time remains for the underlying price to move favorably ✓
- C. Rising interest rates
- D. An increase in the underlying asset's dividend
Why: Time decay, also called theta, is the erosion of an option's time value as expiration nears. With less time left, there is less opportunity for the underlying price to move in the option holder's favor, so time value shrinks toward zero at expiration.
Module 4
Module 4: The Greeks: Delta, Gamma, Theta, Vega
The Greeks: Delta, Gamma, Theta, Vega
Knowledge check
Q1. What does delta measure in an option's price?
- A. The rate of change of the option's price with respect to time to expiration
- B. The rate of change of the option's price with respect to a $1 change in the underlying asset's price ✓
- C. The rate of change of delta with respect to the underlying asset's price
- D. The sensitivity of the option's price to changes in implied volatility
Why: Delta measures how much an option's price is expected to change for a $1 move in the underlying asset. Call deltas range from 0 to 1, and put deltas range from -1 to 0.
Q2. Which Greek measures the rate at which an option loses value as time passes, all else being equal?
- A. Delta
- B. Gamma
- C. Theta ✓
- D. Vega
Why: Theta represents time decay. It is usually negative for long option positions because options lose extrinsic value as expiration approaches.
Q3. What does gamma measure?
- A. The change in an option's price for a 1% change in volatility
- B. The change in delta for a $1 change in the underlying asset's price ✓
- C. The change in theta for a one-day change in time
- D. The change in the option's price for a $1 change in the strike price
Why: Gamma is the rate of change of delta relative to the underlying price. It shows how quickly delta itself will shift as the underlying moves, and it is highest for at-the-money options near expiration.
Q4. Vega measures an option's sensitivity to which factor?
- A. Changes in interest rates
- B. Changes in the underlying asset's price
- C. Changes in implied volatility ✓
- D. Changes in time to expiration
Why: Vega measures how much an option's price changes for a 1 percentage point change in implied volatility. Long options have positive vega, meaning they gain value when volatility rises.
Q5. A call option has a delta of 0.60. If the underlying stock rises by $2, approximately how much should the option price change?
- A. $0.60
- B. $1.20 ✓
- C. $2.00
- D. $0.30
Why: Delta of 0.60 multiplied by a $2 move in the underlying gives an expected option price change of about $1.20. This is an approximation, since delta itself changes as the price moves.
Module 5
Module 5: Implied Volatility and Market Sentiment
Implied Volatility and Market Sentiment
Knowledge check
Q1. What does implied volatility represent in an options contract?
- A. The historical price movement of the underlying stock over the past year
- B. The market's expectation of how much the underlying asset's price will move in the future ✓
- C. The difference between the strike price and the current stock price
- D. The total trading volume of the option contract
Why: Implied volatility is derived from the current option price and reflects the market's forecast of future price fluctuations of the underlying asset. It is forward-looking, unlike historical volatility, which measures past price movement.
Q2. Generally, what happens to an option's price when implied volatility increases, all else being equal?
- A. The option's price decreases because uncertainty reduces value
- B. The option's price increases because higher expected movement raises the chance of a profitable outcome ✓
- C. The option's price stays the same because volatility does not affect premiums
- D. The option's price becomes fixed until expiration
Why: Both call and put options gain value as implied volatility rises, because a wider range of possible future prices increases the probability that the option finishes in the money. Option buyers benefit from higher volatility, while sellers face greater risk.
Q3. What is the VIX index commonly referred to as?
- A. The fear gauge ✓
- B. The dividend yield index
- C. The bond market benchmark
- D. The interest rate indicator
Why: The CBOE Volatility Index (VIX) measures the market's expected 30-day volatility of the S&P 500, derived from S&P 500 index option prices. It is often called the 'fear gauge' because it tends to rise during periods of market stress and uncertainty.
Q4. Which statement best describes the volatility smile?
- A. A pattern where implied volatility is the same across all strike prices
- B. A pattern where implied volatility is higher for deep in-the-money and out-of-the-money options than for at-the-money options ✓
- C. A pattern where implied volatility rises steadily as expiration approaches
- D. A pattern showing that call and put prices always move in opposite directions
Why: The volatility smile describes how implied volatility often varies by strike price, forming a U-shaped curve where options far from the current price carry higher implied volatility than at-the-money options. This reflects demand for protection against extreme price moves.
Q5. Why do traders often sell options when implied volatility is unusually high?
- A. Because high implied volatility guarantees the option will expire worthless
- B. Because high implied volatility means option premiums are relatively expensive, which can favor sellers if volatility later falls ✓
- C. Because high implied volatility removes all risk from the position
- D. Because exchanges require sellers to act when volatility is high
Why: When implied volatility is elevated, option premiums are inflated relative to typical levels. Sellers collect higher premiums and may profit if volatility reverts to its average, which lowers option prices. However, sellers still face substantial risk if actual price movement exceeds expectations.
Module 6
Module 6: Common Options Strategies
Common Options Strategies
Knowledge check
Q1. What is the maximum loss for the buyer of a long call option?
- A. Unlimited, because the stock price can rise indefinitely
- B. The premium paid for the option ✓
- C. The strike price minus the current stock price
- D. The difference between the stock price and the premium
Why: A long call buyer pays a premium upfront. If the option expires worthless, the buyer loses only that premium. The downside is capped, while the upside potential is theoretically unlimited.
Q2. An investor owns 100 shares of a stock and sells one call option against those shares. What is this strategy called?
- A. Protective put
- B. Long straddle
- C. Covered call ✓
- D. Iron condor
Why: Selling a call option while owning the underlying shares is called a covered call. The shares cover the obligation to deliver stock if the call is exercised, and the investor collects premium income in exchange for capping upside gains.
Q3. Which strategy involves buying a put option on a stock you already own?
- A. Covered call
- B. Protective put ✓
- C. Short straddle
- D. Bull call spread
Why: A protective put is a put option bought on shares already held. It acts like insurance, setting a floor on losses if the stock price falls below the put's strike price, minus the premium paid.
Q4. An investor expects a stock to move sharply in either direction but is unsure which way. Which strategy fits best?
- A. Long straddle ✓
- B. Covered call
- C. Cash-secured put
- D. Bear put spread
Why: A long straddle involves buying both a call and a put at the same strike price and expiration. It profits from a large move in either direction, which suits an expectation of high volatility without a clear directional view.
Q5. In a bull call spread, what is the main purpose of selling a higher-strike call while buying a lower-strike call?
- A. To eliminate all risk from the trade
- B. To reduce the net cost of the position, at the expense of capping maximum profit ✓
- C. To receive the full premium with no obligations
- D. To profit if the stock price falls
Why: Selling the higher-strike call offsets part of the cost of the long call, lowering the net debit. The tradeoff is that gains are capped at the difference between the two strikes minus the net cost.
Module 7
Module 7: Risk Management and Position Sizing
Risk Management and Position Sizing
Knowledge check
Q1. What is the maximum loss when you buy a call option?
- A. Unlimited, because the stock price can rise indefinitely
- B. The premium paid for the option ✓
- C. The full strike price multiplied by 100 shares
- D. The difference between the stock price and the strike price
Why: When you buy a call option, your maximum loss is limited to the premium you paid. If the option expires worthless, you lose only that premium, regardless of how far the stock falls.
Q2. Which of the following is the most common guideline for position sizing per trade for a beginner options trader?
- A. Risk up to 50% of the account on each trade
- B. Risk about 1% to 2% of the total account value on any single trade ✓
- C. Invest the entire account in one high-conviction trade
- D. Risk whatever amount the broker allows on margin
Why: Risking roughly 1% to 2% of total account value per trade limits the damage from any single losing position, helping preserve capital through a string of losses.
Q3. What does a stop-loss order accomplish in risk management?
- A. It guarantees a profit once the stock reaches a target price
- B. It automatically closes a position when the price reaches a predefined level, capping losses ✓
- C. It increases the number of contracts you can hold
- D. It locks in the option's premium regardless of market movement
Why: A stop-loss order triggers an exit when the price moves against you to a set level, limiting how much you can lose on a position. It does not guarantee a profit or change position size.
Q4. If you sell a naked call option, what is your risk profile?
- A. Limited loss equal to the premium received
- B. Limited loss equal to the strike price
- C. Potentially unlimited loss if the stock price rises sharply ✓
- D. No risk, since you collected the premium upfront
Why: Selling a naked call obligates you to deliver shares if assigned. Because the stock price has no ceiling, losses can grow without limit as the stock rises, while your maximum gain is only the premium received.
Q5. Why do experienced traders often consider position size more important than picking the perfect trade?
- A. Position size determines whether the trade is profitable before it happens
- B. Even good trade ideas can fail, so controlling how much you risk on each trade protects you from catastrophic losses ✓
- C. Larger positions always produce higher returns with no added risk
- D. Position size only matters for stock trading, not options
Why: No strategy wins every time. Sizing positions so that no single loss is devastating keeps you in the game long enough for your edge to play out over many trades.