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CHAPTER 6: BASIC OPTION STRATEGIES END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. When a call is purchased, the buyer pays for both the time value and the intrinsic value of the option. As the call gets closer and closer to expiration, it will lose its time value. At expiration of the call, the holder collects only the intrinsic value. By selling the call prior to expiration, the holder is able to recover some of the time value previously purchased. For a given stock price, this increases the profit or decreases the loss; however, the shorter the holding period, the less time the stock price has to move upward. The tradeoff in deciding whether to sell an option early is between cutting the loss of time value and giving the stock enough time to make a substantial move. 2. The call with a higher exercise price will be far more speculative, because the stock price must go higher in order to break even; however, the premium on such a call will be lower. A call with a lower exercise price will have a greater chance of expiring in-the-money; however, the premium will be higher. The tradeoff is between taking a gamble on the call with a higher exercise price at the cost of a small premium or buying the safer call with a lower exercise price at the cost of a larger premium. 3. A protective put establishes a minimum price at which a stock can be sold. In a bear market, the stock will lose value that can be recovered by exercising the put. This makes the put like an insurance policy that pays off in the event of a loss. The premium on the put is like the premium on the insurance policy. If the price of the stock goes up, the insurance is not needed, so the put is allowed to expire. 4. The higher the exercise price, the higher the price at which the stock can be sold. This reduces the overall loss in a bear market, but, of course, will require a higher premium. It is, therefore, like taking a lower deductible in an insurance policy. By forcing the insurer (the put wri