1. What is the purpose of a protective put strategy?
A. To generate additional income from the stock
B. To speculate on large price movements
C. To limit the downside risk of a stock investment
D. To take advantage of the stock's price movement
A protective put strategy involves holding a long position in the underlying stock and buying a put option, which limits the downside risk while still allowing for gains if the stock price rises, minus the cost of the put.
2. How does a protective put strategy impact the stock’s potential profit?
A. It limits the profit by the amount paid for the put option
B. It increases profit potential without any limitations
C. It eliminates all downside risk but caps profit potential
D. It results in higher potential returns compared to the stock alone
A protective put limits the profit potential by the cost of the put premium while allowing for profit from stock price increases up to that cost.
3. What is the effect of a covered call strategy on the stock’s upside potential?
A. It increases the stock’s upside potential
B. It eliminates any downside risk
C. It caps the upside potential at the strike price of the call option
D. It allows unlimited upside potential
In a covered call strategy, the upside potential is capped because the option writer has sold a call, and any gain beyond the strike price of the call is forfeited.
4. Why would an investor use a covered call strategy?
A. To protect against a significant drop in stock price
B. To generate income from a stock not expected to rise above the strike price
C. To speculate on the potential for a large price increase
D. To limit the downside risk without any cost
A covered call strategy is used by investors who believe the stock will not rise above the strike price, allowing them to collect option premiums while still holding the stock.
5. What does the investor receive in exchange for capping the upside potential in a covered call strategy?
A. The investor receives dividends from the stock
B. The investor receives the stock price appreciation beyond the strike price
C. The investor receives the option premium
D. The investor receives an additional call option for free
In a covered call strategy, the investor receives the option premium in exchange for limiting the potential upside gain beyond the strike price of the call.
6. What is the main benefit of implementing a protective put strategy?
A. It allows for unlimited profit potential while limiting downside risk
B. It provides insurance against significant declines in stock price
C. It ensures that the investor always profits from the stock
D. It generates extra income from the stock without taking any risk
The main benefit of a protective put is that it acts as insurance against large declines in stock price while still allowing the investor to benefit from price increases, minus the cost of the put premium.
7. What are Principal Protected Notes (PPNs)?
A. Securities that offer high risk and no guaranteed returns
B. Securities that invest solely in stocks
C. Securities that offer principal protection and potential gains from options
D. Securities that focus only on bond investments with no options
Principal Protected Notes (PPNs) are investment vehicles that provide principal protection while allowing for participation in gains, usually derived from options on a portfolio, without incurring losses.
8. Which of the following conditions is necessary to create a Principal Protected Note (PPN)?
A. The investment must have an income stream
B. The investor must be guaranteed unlimited gains from the stock market
C. The PPN must be made up of real estate investments
D. The investment must be backed by government bonds only
For a PPN to be created, it must be derived from an investment that provides an income stream, such as a zero-coupon bond, and the option on the portfolio allows participation in its gains.
9. In a Principal Protected Note (PPN), what happens if the underlying option is not exercised?
A. The investor loses part of the principal investment
B. The investor earns income from the option premium
C. The investor does not incur any losses on the principal
D. The investor's principal is forfeited to cover the option cost
In a PPN, if the underlying call option is not exercised (i.e., if the stock's price does not rise enough), the investor does not incur any losses on the principal investment.
10. What is a key drawback of investing in Principal Protected Notes (PPNs)?
A. PPNs provide guaranteed high returns regardless of market conditions
B. The investor forfeits interest income and potential income from the underlying assets
C. PPNs have no risk associated with the investment
D. PPNs require investors to take on significant debt to participate
A key drawback of PPNs is that investors forgo interest income from the principal and any potential income from the underlying assets, as the principal is invested in a zero-coupon bond.
11. Which investment component is used in a Principal Protected Note to provide principal protection?
A. Dividend-paying stocks
B. Corporate bonds
C. Treasury bills
D. A zero-coupon bond
Principal protection in a PPN is provided by investing in a zero-coupon bond, which ensures that the original principal is returned to the investor at maturity.
12. What is the role of the call option in a Principal Protected Note (PPN)?
A. To guarantee that the investor receives the maximum possible return
B. To provide income to the investor throughout the life of the investment
C. To allow the investor to participate in potential gains from the underlying asset
D. To reduce the cost of the zero-coupon bond
The call option in a PPN allows the investor to benefit from potential gains in the underlying asset while ensuring that principal protection is maintained through the zero-coupon bond.
13. Which of the following best describes a covered call strategy?
A. Buying a call option and the underlying stock at the same time
B. Owning a share of stock and simultaneously selling a call option on that stock
C. Purchasing a share of stock and simultaneously selling a put option on that stock
D. Short selling a stock and simultaneously selling a call option on that stock
A covered call strategy involves owning the underlying stock and selling a call option on that stock. This strategy generates income but limits the upside potential to the strike price of the sold call.
14. In a bull call spread strategy, which of the following is true?
A. The investor buys a call option with a lower strike price and sells a call option with a higher strike price
B. The investor buys a put option with a lower strike price and sells a call option with a higher strike price
C. The investor sells a call option with a lower strike price and buys a put option with a higher strike price
D. The investor buys a put option with a higher strike price and sells a put option with a lower strike price
A bull call spread involves buying a call option with a lower strike price and selling a call option with a higher strike price. This strategy benefits from moderate price increases in the underlying asset.
15. What is the primary objective of a bear call spread strategy?
A. To profit from rising stock prices
B. To profit from stable stock prices
C. To profit from falling stock prices while limiting the risk of sharp increases
D. To hedge against large losses in a portfolio
A bear call spread profits from falling stock prices while limiting the risk of sharp price increases. The strategy involves selling a call option with a lower strike price and buying a call option with a higher strike price.
16. In a bull put spread strategy, the investor would:
A. Buy a put with a lower strike price and sell a put with a higher strike price
B. Sell a put with a higher strike price and buy a put with a lower strike price
C. Buy a call option with a higher strike price and sell a call option with a lower strike price
D. Buy a call option with a lower strike price and sell a call option with a higher strike price
A bull put spread involves buying a put with a higher strike price and selling a put with a lower strike price. The strategy profits from a moderate increase in the price of the underlying asset.
17. Which of the following best describes a butterfly spread strategy?
A. A strategy where an investor holds a combination of long and short positions in options with different strike prices, but the same expiration date
B. A strategy where an investor simultaneously buys and sells options with three different strike prices
C. A strategy involving two call options with the same strike price and a long position in one put option
D. A strategy involving only long positions in options
A butterfly spread involves buying and selling options with three different strike prices. This strategy aims to profit from a stock price remaining near the middle strike price at expiration.
18. A calendar spread involves:
A. Buying and selling options with the same strike price but different expiration dates
B. Buying and selling options with the same expiration date but different strike prices
C. Buying and selling options with the same expiration date and strike price
D. Selling only long options with different expiration dates
A calendar spread involves buying and selling options with the same strike price but different expiration dates. This strategy profits from time decay and volatility differences between the two options.
19. In a butterfly spread strategy, the investor buys:
A. One call with a low exercise price, one call with a high exercise price, and sells two calls with an intermediate strike price
B. One put with a low exercise price, one put with a high exercise price, and sells two puts with an intermediate strike price
C. Two calls with a low exercise price, one call with a high exercise price, and sells one call with an intermediate strike price
D. One call with a high exercise price and sells two calls with low and intermediate strike prices
A butterfly spread involves buying one call with a low exercise price, one call with a high exercise price, and selling two calls with an intermediate strike price. This strategy profits if the stock price stays near the middle strike price at expiration.
20. The main goal of a butterfly spread strategy is to:
A. Profit from significant movements in stock prices
B. Profit from a stock price staying near the strike price of the written calls
C. Limit losses when stock prices move drastically
D. Protect a portfolio from sharp price declines
The goal of a butterfly spread is to profit from a stock price remaining near the strike price of the written calls, while limiting the potential for large losses if the price moves away from this level.
21. In a butterfly spread, if the stock price moves significantly away from the middle strike price, the payoff will be:
A. Zero or negative, depending on the direction of the move
B. Unlimited profit or loss, depending on the direction of the move
C. Zero for large moves in either direction
D. Positive, no matter how far the stock price moves
In a butterfly spread, if the stock price moves significantly away from the middle strike price, the payoff will be zero. This is because the loss from one leg is offset by the gain from another leg, but the net result is zero or a small loss.
22. A butterfly spread with put options involves:
A. Buying one put with a low strike price, buying one put with a high strike price, and selling two puts with an intermediate strike price
B. Buying one call with a low strike price, buying one call with a high strike price, and selling two calls with an intermediate strike price
C. Selling one put with a low strike price and buying two puts with intermediate strike prices
D. Buying one call with a high strike price and selling two calls with low strike prices
A butterfly spread with puts involves buying a put with a low strike price, buying a put with a high strike price, and selling two puts with an intermediate strike price. This strategy profits from a stock price staying near the middle strike price at expiration.
23. A calendar spread is created by:
A. Buying options with different strike prices and same expiration dates
B. Buying and selling options with the same strike price but different expiration dates
C. Selling options with different strike prices and different expiration dates
D. Buying options with the same strike price and same expiration dates
A calendar spread involves buying and selling options with the same strike price but different expiration dates. The strategy profits when the stock remains in a narrow range.
24. In a diagonal spread, the options involved typically have:
A. Different strike prices and different expiration dates
B. Same strike prices and different expiration dates
C. Same strike prices and same expiration dates
D. Different strike prices and same expiration dates
A diagonal spread involves options with different strike prices and different expiration dates, as opposed to a calendar spread which uses the same strike price.
25. A box spread strategy typically combines:
A. A bull call spread and a bear call spread
B. A bear call spread and a bear put spread
C. A bull call spread and a bear put spread
D. A bull put spread and a bull call spread
A box spread strategy combines a bull call spread and a bear put spread on the same asset, creating a constant payoff equal to the difference between the high and low exercise prices.
26. The payoff from a box spread is:
A. Uncertain, depending on the volatility of the underlying asset
B. Equal to the difference between the high and low exercise prices
C. Based on the strike prices of the options involved
D. Equal to the premium paid for the options
The payoff from a box spread is equal to the difference between the high and low exercise prices, and under no-arbitrage conditions, it equals the net premium paid.
27. Box spread arbitrage is only successful with:
A. American options
B. Exotic options
C. Options with a high implied volatility
D. European options
Box spread arbitrage is successful only with European options because they can only be exercised at expiration, eliminating early exercise risk, which is essential for this strategy to function correctly.
28. A long straddle strategy involves:
A. Purchasing both a call and a put with the same strike price and expiration date
B. Selling both a call and a put with the same strike price and expiration date
C. Purchasing a call and a put with different strike prices
D. Selling both a call and a put with different strike prices
A long straddle involves purchasing both a call and a put option with the same strike price and expiration date. This strategy profits when the stock price moves significantly in either direction.
29. A strangle strategy differs from a straddle in that:
A. The options have the same strike prices
B. The options are slightly out-of-the-money, and the strike prices are different
C. It requires a higher premium than a straddle
D. The options are closer to being in-the-money
A strangle involves purchasing out-of-the-money call and put options with different strike prices. It is cheaper to implement than a straddle but requires a larger price movement to become profitable.
30. The payoff of a long straddle is:
A. Always flat with no significant movement
B. Profitable only when the stock price stays within a narrow range
C. Symmetric around the strike price and profitable when the stock price moves significantly in either direction
D. Profitable only when the stock price does not change significantly
The payoff of a long straddle is symmetric around the strike price and is profitable when the stock price moves significantly in either direction.
31. A key characteristic of a strangle strategy is:
A. It is cheaper to implement compared to a straddle
B. The payoff is always positive regardless of stock price movement
C. It requires the stock to move significantly less than a straddle
D. The payoff is profitable only when the stock price stays within a narrow range
A strangle is cheaper to implement than a straddle but requires a larger movement in the stock price to become profitable due to the strike prices being out-of-the-money.
32. A strip strategy involves:
A. Purchasing two puts and one call with the same strike price and expiration
B. Purchasing two calls and one put with the same strike price and expiration
C. Purchasing one call and one put with the same strike price and expiration
D. Selling one call and one put with the same strike price and expiration
A strip strategy involves purchasing two puts and one call with the same strike price and expiration, making it more bearish since it pays off more on the downside.
33. A strap strategy involves:
A. Purchasing two puts and one call with the same strike price and expiration
B. Purchasing two calls and one put with the same strike price and expiration
C. Purchasing one call and one put with the same strike price and expiration
D. Selling one call and one put with the same strike price and expiration
A strap strategy involves purchasing two calls and one put with the same strike price and expiration. It is more bullish as it pays off more on the upside.
34. The primary difference between a strip and a strap strategy is:
A. A strip is more bullish while a strap is more bearish
B. A strip involves the purchase of calls only, while a strap involves puts only
C. A strip is more bearish and pays off more on the downside, while a strap is more bullish and pays off more on the upside
D. Both strategies involve the same number of calls and puts with identical strike prices and expirations
The main difference between a strip and a strap is that a strip is more bearish, betting on volatility with a greater payoff on the downside, whereas a strap is more bullish, betting on volatility with a greater payoff on the upside.
35. A strip strategy is best suited for:
A. A scenario with little to no price movement expected
B. A scenario with high volatility and a bearish outlook
C. A scenario with high volatility and a bullish outlook
D. A scenario with moderate price movement expected
A strip strategy is best suited for high volatility with a bearish outlook, as it pays off more on the downside.
36. A strap strategy is best suited for:
A. A scenario with little to no price movement expected
B. A scenario with high volatility and a bearish outlook
C. A scenario with high volatility and a neutral outlook
D. A scenario with high volatility and a bullish outlook
A strap strategy is best suited for high volatility with a bullish outlook, as it pays off more on the upside.
37. An investor believes that a stock will either increase or decrease greatly in value over the next few months, but a downward move is more likely. Which strategy would be most suitable for this investor?
A. A protective put
B. An at-the-money strip
C. An at-the-money strap
D. A straddle
The most suitable strategy in this case would be an at-the-money strip. This strategy involves purchasing two puts and one call, which is bearish because it has more weight on the downside. The investor is betting on significant volatility, with a higher payoff if the stock price decreases.
38. Why might an investor choose to write a covered call strategy?
A. To protect against a stock price decline and benefit from unlimited upside.
B. To profit if the stock price rises significantly in a short period.
C. To generate income from call premiums when expecting limited stock price movement.
D. To hedge a short position using deep in-the-money calls.
The correct answer is C. Writing a covered call involves holding a stock and selling a call option on that stock. This strategy is typically used to enhance income when the investor expects the stock to stay flat or rise only slightly. The risk is that the upside is capped if the stock price exceeds the strike price.
39. Which of the following statements is TRUE regarding spread strategies?
A. A short butterfly spread is ideal when expecting minimal movement in the stock price.
B. A bear spread with calls is constructed by buying a call with a lower strike and selling a call with a higher strike.
C. Bear spreads can only be constructed using call options.
D. A bear put spread involves buying a put with a higher strike price and selling a put with a lower strike price, profiting if the stock price falls.
The correct answer is D. A bear put spread involves buying a put with a higher strike price and selling one with a lower strike price. This strategy profits when the stock price declines, as the put options become valuable. The investor earns the difference in strike prices minus the net premium paid.
40. Which of the following best describes the payoff of a butterfly spread?
A. The payoff increases as the stock price moves significantly in either direction.
B. The payoff is highest when the stock price is at the strike price of the written calls.
C. The payoff is the same for any stock price at expiration.
D. The payoff is only positive if the stock price exceeds the highest strike price.
The correct answer is B. In a butterfly spread, the maximum payoff occurs when the stock price is at the strike price of the written calls. The strategy profits when the stock price stays near this strike price, and losses are limited if the stock price moves away from it.
41. A calendar spread profits when:
A. The stock price moves significantly in either direction.
B. The stock price remains well above or well below the strike price of the options.
C. The stock price stays in a narrow range near the strike price.
D. The stock price moves dramatically and quickly.
The correct answer is C. A calendar spread profits when the stock price remains in a narrow range near the strike price, as it involves options with the same strike price but different expiration dates. The strategy is sensitive to time decay and volatility.
42. Which of the following is true about a diagonal spread?
A. It uses options with the same strike price and expiration dates.
B. It can only be constructed using call options.
C. It involves the purchase of a call option and the sale of a put option.
D. It uses options with different strike prices and expiration dates.
The correct answer is D. A diagonal spread involves options with different strike prices and expiration dates. It combines elements of both a calendar spread (different expirations) and a vertical spread (different strike prices).
43. Which of the following strategies will produce a constant payoff equal to the difference between the high and low strike prices?
A. Box spread
B. Butterfly spread
C. Straddle
D. Calendar spread
The correct answer is A. A box spread produces a constant payoff equal to the difference between the high and low strike prices. It combines a bull call spread and a bear put spread and is typically used in arbitrage.
