Sammy Bonami buys a MSFT May 55 call @3. When MSFT rises to $62 a share, Sammy sells 100 shares short, then covers the short position by exercising the call option. What is the result of Sammy's trading activity?
A. gain of $7 per share
B. gain of $4 per share
C. loss of $10 per share
D. loss of $3 per share
EXPLANATION: this is exactly how a trader would exercise a call. In order to take advantage of the temporary market price of $62, Sammy needs to sell the stock short now. At this point he can "cover his short position" by exercising his right to buy the stock for $55 a share. He doesn't keep the full $7 a share difference, since he paid $3 a share for the right to buy the stock at $55. He keeps $4 per share.
Some test-takers would report that they have "never seen anything like this before," but, in fact, they have learned the fundamentals that would allow them to figure it out with strategy and patience. Our Pass the 65 book covers options in more detail than it probably should, and--no matter what we cover in the book--the exam wants to see if you can apply the fundamentals in a very unexpected, challenging way. You have to figure this sort of question out. Ask yourself, "what does a call buyer get to do?" He gets to buy at the strike price--okay, so have him pay the strike price and the premium. You see that he "sells" the stock for $62 a share, so that has to offset the $58 per share that he paid. Are you 100% confident with your answer? Heck no--luckily, you only need a 68.5% to pass before 1/1/10, and a 72% to pass thereafter.
Be preapred to figure things out at the testing center--no matter what you've studied, the test questions will force you to apply the concepts in unexpected, seemingly impossible ways. You don't get to spit back the little flash cards you've memorized on the Series 65 or 66. You have to use logic and test-taking skills to apply the fundamentals in a very challenging, often confusing environment.