Options & Derivatives Trading Flashcards

A credit default swap (CDS) provides protection against:

Answer: A borrower's default on debt obligations

A CDS is a derivative that transfers credit risk, compensating the protection buyer if the reference entity defaults on its debt.

An iron condor strategy profits most when the underlying stock:

Answer: Stays within a defined price range

An iron condor profits from low volatility when the stock stays between the two short strikes, allowing all premium to decay.

What is the 'volatility smile' observed in options markets?

Answer: The pattern where out-of-the-money puts have higher implied volatility than at-the-money options

The volatility smile (or skew) shows that OTM puts often carry higher implied volatility than ATM options, reflecting demand for downside protection.

When a futures contract reaches its expiration, a cash-settled contract results in:

Answer: Payment of the difference between the futures price and the final settlement price

Cash-settled futures settle by transferring the profit or loss based on the difference between the traded price and the final settlement price.

Which of the following best describes 'pin risk' in options trading?

Answer: The uncertainty when a stock closes exactly at a strike price at expiration

Pin risk occurs when the underlying closes at or very near a strike price at expiration, creating uncertainty about whether the option will be exercised.

A collar strategy combines which two options positions along with a long stock position?

Answer: Long put and short call

A collar protects a long stock position by buying a put for downside protection while selling a call to offset the cost.

The Black-Scholes model assumes which of the following about stock price movements?

Answer: Stock prices follow a lognormal distribution with constant volatility

The Black-Scholes model assumes stock prices follow geometric Brownian motion with constant volatility, implying a lognormal distribution of returns.