Question 1

Which of the following creates a bear spread?
A)Buy a low strike price call and sell a high strike price call
B)Buy a high strike price call and sell a low strike price call
C)Buy a low strike price call and sell a high strike price put
D)Buy a low strike price put and sell a high strike price call

Accepted Answer

A bear spread is created by buying a high strike price call option and selling a low strike price call option. This strategy profits from a decrease in the price of the underlying asset, as the sold call option will lower the overall cost of the trade while limiting potential profits. Choices A, C, and D do not create a bear spread.

Question 2

How can a strap trading strategy be created?
A)Buy one call and one put with the same strike price and same expiration date
B)Buy one call and one put with different strike prices and same expiration date
C)Buy one call and two puts with the same strike price and expiration date
D)Buy two calls and one put with the same strike price and expiration date

Accepted Answer

A strap consists of two calls and one put with the same strike price and time to maturity.

Question 3

Six-month call options with strike prices of $35 and $40 cost $6 and $4,respectively.What is the maximum gain when a bull spread is created by trading a total of 200 options?
A)$100
B)$200
C)$300
D)$400

Accepted Answer

To create a bull spread, we need to buy a lower strike call option and sell a higher strike call option. In this case, we will buy 100 call options with a strike price of $35 for $6 each, costing a total of 100*$6 = $600. We will sell 100 call options with a strike price of $40 for $4 each, earning a total of 100*$4 = $400.

The maximum gain from a bull spread is the difference in strike prices minus the net premium paid. In this case, the difference in strike prices is $40 - $35 = $5. The net premium paid is $600 - $400 = $200. Therefore, the maximum gain is $5*100 - $200 = $300. So, the best choice is (C).

Question 4

How can a straddle be created?
A)Buy one call and one put with the same strike price and same expiration date
B)Buy one call and one put with different strike prices and same expiration date
C)Buy one call and two puts with the same strike price and expiration date
D)Buy two calls and one put with the same strike price and expiration date

Accepted Answer

A straddle consists of one call and one put where the strike price and time to maturity are the same.It has a V-shaped payoff.

Question 5

Which of the following is correct?
A)A diagonal spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different
B)A diagonal spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different
C)A diagonal spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different
D)A diagonal spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different

Accepted Answer

Both the strike prices and times to maturity are different in a diagonal spread.

Question 6

Which of the following is correct?
A)A calendar spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different
B)A calendar spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different
C)A calendar spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different
D)A calendar spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different

Accepted Answer

A calendar spread is an options trading strategy that involves buying and selling options on the same underlying asset with different expiration dates. The key to a calendar spread is that the strike price of the two options should be the same, but with different expiration dates. Therefore, option buying and selling would be required with the same strike price but different maturity dates in a calendar spread. Option A and B do not have the same strike price, and option C has different strike prices. Therefore, option D is the correct choice.

Question 7

Which of the following describes a protective put?
A)A long put option on a stock plus a long position in the stock
B)A long put option on a stock plus a short position in the stock
C)A short put option on a stock plus a short call option on the stock
D)A short put option on a stock plus a long position in the stock

Accepted Answer

A protective put is a strategy used to protect against a decrease in the price of a stock. It involves buying a long put option on a stock and holding a long position in the stock at the same time. This allows the investor to lock in a minimum selling price for the stock while still participating in any potential price increases. Choice A describes this strategy.

Question 8

Which of the following is true of a box spread?
A)It is a package consisting of a bull spread and a bear spread
B)It involves two call options and two put options
C)It has a known value at maturity
D)All of the above

Accepted Answer

All of the options listed are true of a box spread. It involves two call options and two put options, which can be used to create both a bull spread and a bear spread. Because of this, the box spread has a known value at maturity, making it a popular choice among risk-averse investors.

Question 9

Which of the following creates a bull spread?
A)Buy a low strike price call and sell a high strike price call
B)Buy a high strike price call and sell a low strike price call
C)Buy a low strike price call and sell a high strike price put
D)Buy a low strike price put and sell a high strike price call

Accepted Answer

A bull spread strategy involves buying a call option at a lower strike price and selling a call option at a higher strike price. This allows the trader to profit from an increase in the underlying asset's price while limiting their potential losses. Choice B creates a bear spread, choice C creates a ratio spread, and choice D creates a bear put spread.

Question 10

How can a strangle trading strategy be created?
A)Buy one call and one put with the same strike price and same expiration date
B)Buy one call and one put with different strike prices and same expiration date
C)Buy one call and two puts with the same strike price and expiration date
D)Buy two calls and one put with the same strike price and expiration date

Accepted Answer

A strangle strategy involves buying one call option and one put option with different strike prices but the same expiration date. This allows the trader to profit from a significant move in either direction, as the call option will increase in value if the price goes up, and the put option will increase in value if the price goes down. Option C involves buying two puts, which would limit the potential profit and increase the cost of the trade. Option D involves buying two call options, which would indicate that the trader is only looking for a bullish move and not considering the possibility of a bearish move. Option A involves buying two options with the same strike price, which would limit the potential profit and make it more difficult to profit from a significant move in either direction.

Question 11

What is the number of different option series used in creating a butterfly spread?
A)1
B)2
C)3
D)4

Accepted Answer

A butterfly spread involves buying and selling multiple options with different strikes and expirations. Therefore, multiple option series would be needed to create a butterfly spread. Specifically, a butterfly spread involves buying one call (or put) option with a lower strike price, selling two call (or put) options with a middle strike price, and buying one call (or put) option with a higher strike price. This requires three different option series, with the two middle strike options coming from the same series.

Question 12

A trader creates a long butterfly spread from options with strike prices $60,$65,and $70 by trading a total of 400 options.The options are worth $11,$14,and $18.What is the maximum net loss (after the cost of the options is taken into account)?
A)$100
B)$200
C)$300
D)$400

Accepted Answer

The butterfly spread involves buying 100 options with strike prices $60 and $70 and selling 200 options with strike price $65.The maximum loss is when the stock price is less than $60 or greater than $70.The total payoff is then zero.The cost of setting up the butterfly spread is 11×100+18×100−14×200 = $100.The loss is therefore $100.

Question 13

Which of the following creates a bull spread?
A)Buy a low strike price put and sell a high strike price put
B)Buy a high strike price put and sell a low strike price put
C)Buy a high strike price call and sell a low strike price put
D)Buy a high strike price put and sell a low strike price call

Accepted Answer

A bull spread is created by buying a low strike call and selling a high strike call.Alternatively,it can be created by buying a low strike put and selling a high strike put.

Question 14

When the interest rate is 5% per annum with continuous compounding,which of the following creates a $1000 principal protected note?
A)A one-year zero-coupon bond plus a one-year call option worth about $59
B)A one-year zero-coupon bond plus a one-year call option worth about $49
C)A one-year zero-coupon bond plus a one-year call option worth about $39
D)A one-year zero-coupon bond plus a one-year call option worth about $29

Accepted Answer

To create a principal protected note, we need to buy a zero-coupon bond and a call option. The strike price of the call option should be equal to the face value of the bond ($1000 in this case).

Using the Black-Scholes formula, we can calculate the price of the call option as:
Call option price = S*N(d1) - X*exp(-r*T)*N(d2)
where
S = current price of the underlying asset (which is assumed to be the same as the face value of the bond, i.e., $1000)
X = strike price of the option (which is also $1000)
T = time to maturity (1 year in this case)
r = interest rate (5% per annum with continuous compounding)
d1 = [ln(S/X) + (r + (σ^2)/2)*T] / (σ*sqrt(T))
d2 = d1 - σ*sqrt(T)
σ = volatility (which is not given, but we can assume it to be 20%)

Using these values, we get:
d1 = [ln(1000/1000) + (0.05 + 0.2^2/2)*1] / (0.2*sqrt(1)) = 0.325
d2 = 0.325 - 0.2*sqrt(1) = 0.125
N(d1) = 0.627 = N(d2) + 0.2*sqrt(1) = 0.525
Call option price = 1000*0.627 - 1000*exp(-0.05*1)*0.525 = $48.91

Therefore, the correct option is B, which offers a call option worth about $49.

Question 15

What is a description of the trading strategy where an investor sells a 3-month call option and buys a one-year call option,where both options have a strike price of $100 and the underlying stock price is $75?
A)Neutral Calendar Spread
B)Bullish Calendar Spread
C)Bearish Calendar Spread
D)None of the above

Accepted Answer

This is a Bullish Calendar Spread because the investor is selling a shorter-term call option (3-month) and buying a longer-term call option (1-year), indicating a belief that the stock price will increase in the short-term, but also potentially increase in the long-term. The fact that both options have a strike price of $100 while the underlying stock price is $75 suggests that the investor is moderately bullish on the stock.

Question 16

A stock price is currently $23.A reverse (i.e.,short)butterfly spread is created from options with strike prices of $20,$25,and $30.Which of the following is true?
A)The gain when the stock price is greater that $30 is less than the gain when the stock price is less than $20
B)The gain when the stock price is greater that $30 is greater than the gain when the stock price is less than $20
C)The gain when the stock price is greater that $30 is the same as the gain when the stock price is less than $20
D)It is incorrect to assume that there is always a gain when the stock price is greater than $30 or less than $20

Accepted Answer

The gain from a very high stock price or a very low stock price is the same.Suppose calls are used.In the case of a very low stock price none are exercised and the gain is c₁+c₃−2c₂ from the option premium.In the case of a very high stock price all options are exercised.The net payoff is zero and the gain is the same.

Question 17

How can a strip trading strategy be created?
A)Buy one call and one put with the same strike price and same expiration date
B)Buy one call and one put with different strike prices and same expiration date
C)Buy one call and two puts with the same strike price and expiration date
D)Buy two calls and one put with the same strike price and expiration date

Accepted Answer

A strip consists of one call and two puts with the same strike price and time to maturity.

Question 18

Which of the following creates a bear spread?
A)Buy a low strike price put and sell a high strike price put
B)Buy a high strike price put and sell a low strike price put
C)Buy a high strike price call and sell a low strike price put
D)Buy a high strike price put and sell a low strike price call

Accepted Answer

A bear spread is created by buying a high strike call and selling a low strike call.Alternatively,it can be created by buying a high strike put and selling a low strike put.

Question 19

A trader creates a long butterfly spread from options with strike prices $60,$65,and $70 by trading a total of 400 options.The options are worth $11,$14,and $18.What is the maximum net gain (after the cost of the options is taken into account)?
A)$100
B)$200
C)$300
D)$400

Accepted Answer

The butterfly spread involves buying 100 options with strike prices $60 and $70 and selling 200 options with strike price $65.The maximum gain is when the stock price equals the middle strike price,$65.The payoffs from the options are then,$500,0,and 0,respectively.The total payoff is $500.The cost of setting up the butterfly spread is 11×100+18×100−14×200 = $100.The gain is 500−100 or $400.

Question 20

Which of the following describes a covered call?
A)A long call option on a stock plus a long position in the stock
B)A long call option on a stock plus a short put option on the stock
C)A short call option on a stock plus a short position in the stock
D)A short call option on a stock plus a long position in the stock

Accepted Answer

A covered call involves holding a long position in a stock and selling a call option on that same stock, which is represented by a short call option. Therefore, choice D accurately describes a covered call.

Quiz 11: Trading Strategies Involving Options

Which of the following creates a bear spread?

How can a strap trading strategy be created?

Six-month call options with strike prices of $35 and $40 cost $6 and $4,respectively.What is the maximum gain when a bull spread is created by trading a total of 200 options?

How can a straddle be created?

Which of the following is correct?

Which of the following is correct?

Which of the following describes a protective put?

Which of the following is true of a box spread?

Which of the following creates a bull spread?

How can a strangle trading strategy be created?

What is the number of different option series used in creating a butterfly spread?

A trader creates a long butterfly spread from options with strike prices $60,$65,and $70 by trading a total of 400 options.The options are worth $11,$14,and $18.What is the maximum net loss (after the cost of the options is taken into account) ?

Which of the following creates a bull spread?

When the interest rate is 5% per annum with continuous compounding,which of the following creates a $1000 principal protected note?

What is a description of the trading strategy where an investor sells a 3-month call option and buys a one-year call option,where both options have a strike price of $100 and the underlying stock price is $75?

A stock price is currently $23.A reverse (i.e.,short) butterfly spread is created from options with strike prices of $20,$25,and $30.Which of the following is true?

How can a strip trading strategy be created?

Which of the following creates a bear spread?

A trader creates a long butterfly spread from options with strike prices $60,$65,and $70 by trading a total of 400 options.The options are worth $11,$14,and $18.What is the maximum net gain (after the cost of the options is taken into account) ?

Which of the following describes a covered call?