Derivatives – Practice Questions

1. Assume a security is currently trading at $500 per unit. An investor wants to enter into a forward
contract that expires in six months. The current annual risk-free interest rate is 7%. Calculate
the forward price.
F=S×e(r×t)
F = 500xe(0.07x6/12)
F = 517.81

Long Call (Call Option Holder) – Right to Buy (Pays premium)

Short Call (Call Option Seller/Writer) - Obligation to Sell (Receives Premium)
Long Put (Put Option Holder) – Right to Sell (Pays Premium)
Short Put (Put Option Seller/Writer) – Obligation to Buy (Receives Premium)

Long party will always pay premium as they have right to exercise option. Short party will always receive
premium as they have obligation to exercise the option if long wishes to exercise.

2. A call option with a strike price of $75 can be bought for $5.
a. What will be your net profit/(loss) if you buy the call and the stock price is $72 when
the call expires?
The call option will not be exercised as it is out of the money.
Call Option = S – X
= $72 – $75
= -$3 (OTM)
The call option holder/buyer will not exercise this option as it is out of the money and will have net loss
of 5 which is the premium which he paid to purchase this option.

b. What will be your net profit/(loss) if you sell the call and the stock price is $72 when the
call expires?
Call Option = S – X
= $72 – $75
= -$3 (OTM)
Call option is out of the money and the call option buyer will not exercise this option. So in this case, call
option seller/writer will not lose anything although he will earn premium which is $5. So, the net profit of
call option seller/writer will be $5.

c. What should be the stock price at expiration for breakeven?

The strike price is $75 and the option was purchased by paying premium of $5. So for call option holder
the stock price should be strike price plus the premium ($75 + $5 = $80) which he will required to achieve
breakeven point. Below is the calculation.
Call Option = S – X
= $80 – $75
= $5 (ITM)
Call option is in the money by $5 and premium was paid of $5. So net profit/(loss) is 0.
Breakeven = S – X – Premium
= 80 – 75 – 5
=0
Same should be the case for call option writer. The option will be exercised by call option holder and call
option writer will have loss of $5. But this loss will be compensated against premium of $5 which he
received for selling the option. So his net loss will be zero.

3. A call option with a strike price of $40 can be bought for $4.
a. What will be your net profit/(loss) if you buy the call and the stock price is $46 when
the call expires?
The call option will be exercised as it is in the money.
Call Option = S – X
= $46 – $40
= $6 (ITM)
The option is in the money and call option holder/buyer will exercise the option. By exercising this option
he will have gain of $6. Premium which he paid will be deducted from this gain so net gain will be $2 ($6
- $4).

b. What will be your net profit/(loss) if you sell the call and the stock price is $46 when the
call expires?
Call Option = S – X
= $46 – $40
= $6 (ITM)
Call option is in the money and the call option buyer will exercise this option. So in this case, call option
seller/writer will have loss of $6. But the option seller/writer has earned premium of $4 so the net loss
will be $2 ($6-$4).

4. A put option with a strike price of $75 can be bought for $5.

a. What will be your net profit/(loss) if you buy the put and the stock price is $72 when
the put expires?
Put Option = X – S
= $75 – $72
= $3 (ITM)
Put option is in the money and the put option buyer will exercise this option. So in this case, put option
buyer will have gain of $3 for exercising this option. The net profit/(loss) for put option buyer will be:
Total Gain – Premium paid
$3 - $5
Net loss = -$2
After deduction of premium from total gain, the put option buyer will have net loss of $2. Still the put
option buyer will exercise this option as his loss is reducing in this case. If he will let this option expire he
will not have any gain and he has already paid premium of $5 which will be his loss. So to minimize total
loss he will exercise this option.
 b. What will be your net profit/(loss) if you sell the put and the stock price is $72 when the
put expires?
Put Option = X – S
= $75 – $72
= $3 (ITM)
Put option is in the money and the put option buyer will exercise this option. So in this case, put option
seller/writer will have loss of $3. But the option seller/writer has earned premium of $5 so the net gain
will be $2 ($5-$3).

5. A put option with a strike price of $50 can be bought for $3.

a. What will be your net profit/(loss) if you buy the put and the stock price is $57 when
the put expires?
Put Option = X – S
= $50 – $57
= -$7 (OTM)
Put option is out of the money and the put option buyer will not exercise this option. So in this case, put
option buyer will have loss of $3 which is the premium which he paid to purchase this option.

b. What will be your net profit/(loss) if you sell the put and the stock price is $57 when the
put expires?
Put Option = X – S
= $50 – $57
= $7 (OTM)
Put option is out of the money and the put option buyer will exercise not this option. So in this case, put
option seller/writer will have gain of $3 which is the premium which he earned for selling this option.

c. What should be the stock price at expiration for breakeven?

The strike price is $50 and the option was purchased by paying premium of $3. So for put option holder
the stock price should be strike price minus the premium ($50 - $3 = $47) which he will required to achieve
breakeven point. Below is the calculation.
Put Option = X – S
= $50 – $47
= $3 (ITM)
Put option is in the money by $3 and premium was paid of $3. So net profit/(loss) is 0.
Breakeven = X – S – Premium
= 50 – 47 – 3
=0
Same should be the case for call option writer. The option will be exercised by put option holder and put
option writer will have loss of $3. But this loss will be compensated against premium of $3 which he
received for selling the option. So his net loss will be zero.
 6. What will be the maximum loss for call and put option holder?
For out of the money option, the maximum loss for call and put option holder is the premium which he
has paid because out of the money option will not be exercised and the option holder will only lose the
premium which he has already paid.
The holder of option has the maximum loss when option stays out of the money as he loses from the
premium amount which he has already paid. This will be the worst scenario and lose-lose situation for call
and put option holder because in the money option will have lower loss or might have gain post
subtracting premium payment.

Holder of Option – Max. loss is the premium which has been paid.

7. What will be the maximum gain for call and put option writer?
For out of the money option, the maximum gain for call and put option writer is the premium which he
has received because out of the money option will not be exercised and the option writer will only benefit
from the premium which he has already received.
The writer of option has the maximum benefit when option stays out of the money as he benefits from
the premium amount which he has already received. This will be the best scenario and win-win situation
for call and put option writer because in the money option will have lower gain or might have lost post
adding premium received amount.

Writer of Option – Max. benefit/gain is the premium which has been received.