Which of the following is NOT true about call and put options:
a. An American option can be exercised at any time during its life
b. The price of a call option increases as the strike price increases
c. Investors must pay an upfront price (the option premium) for an option contract
d. A European option can only be exercised only on the maturity date
The correct answer and explanation is:
The correct answer is B) The price of a call option increases as the strike price increases.
Explanation:
Call and put options are types of financial derivatives that give investors the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (the strike price) before a certain date. Here is a breakdown of the statements:
- A) An American option can be exercised at any time during its life: This statement is true. An American option can indeed be exercised at any time before or on its expiration date. This flexibility is one of the key characteristics of American options.
- B) The price of a call option increases as the strike price increases: This statement is false. The price of a call option (also called the premium) tends to decrease as the strike price increases. This is because a higher strike price makes the option less likely to be exercised profitably. As the strike price moves further away from the current market price of the underlying asset, the likelihood of the call option ending up in-the-money decreases, which generally lowers its price.
- C) Investors must pay an upfront price (the option premium) for an option contract: This statement is true. When purchasing options, the buyer must pay an upfront premium. This is the price for acquiring the right (but not the obligation) to exercise the option in the future.
- D) A European option can only be exercised on the maturity date: This statement is true. Unlike American options, European options can only be exercised on the expiration date, not before.
In conclusion, B is the correct answer because the price of a call option typically decreases as the strike price increases, contrary to what is stated in the option.