Mock test 2

AMITAG1990
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Joined: Sat Sep 22, 2012 12:35 pm

Mock test 2

Postby AMITAG1990 » Wed Nov 14, 2012 3:18 pm

Tina’s portfolio has a large (negative) theta. She is planning to add a call option on a non dividend paying stock to her portfolio. She doesn’t want the new option to change the overall theta of her portfolio by a large extent. The 6-month call options which she is considering have a time to maturity of 1 month. The current stock price is $105. Which of the following options should she buy?
Choose one answer.
a. Call option with Strike price = $105 Incorrect
b. Call option with Strike price = $100 Correct
c. Call option with Strike price = $115 Incorrect
d. Call option with Strike price = $110 Incorrect
The correct answer is Call option with Strike price = $100.
Explanation.
Theta curve for out of the money options approaches to 0 as the time to expiry nears. Tina should buy the out of the money call option which is the one with strike price of $100.

But y not C or D because ITM call option also aproaches Zero for theta.

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balajismz
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Joined: Mon Nov 05, 2012 9:13 am

Re: Mock test 2

Postby balajismz » Wed Nov 14, 2012 4:27 pm

Agree with you. I got the same query, Someone from admin team can address this

Balaji

content.pristine
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Re: Mock test 2

Postby content.pristine » Thu Nov 15, 2012 8:03 pm

Note that the question says that she does not want to change the theta of the portfolio.
That mean, she must add an option with a large (negative) theta since the portfolio has a large (negative) theta.
Otherwise, if she adds a low theta stock, that would lower the overall theta of the portfolio.

Think about it this way: Lets say we have a portfolio with a Beta of 2. Now, if we add a risk free asset (Beta = 0), that would LOWER the beta of the portfolio.

Hope this helps!
8-)

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

Re: Mock test 2

Postby AMITAG1990 » Thu Nov 15, 2012 8:29 pm

Yes exactly, but in that case she should choose at the money option because that has highest negative theta. i.e answer should be A.?? Correct.??


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