CSC Derivatives and Risk Management 4 — Questions and Answers
Question 1: Which of the following describes a 'straddle' options strategy?
- Buying a call and selling a put at the same strike and expiry
- Buying both a call and a put at the same strike price and expiry (Correct answer)
- Selling a call and selling a put at different strike prices
- Buying a call at one strike and a put at a lower strike
Correct answer: Buying both a call and a put at the same strike price and expiry
A long straddle profits from large price movements in either direction because it holds both a call and a put at the same strike.
Question 2: Under CSC exam content, what is the theoretical fair value of a forward contract most directly based on?
- Historical volatility of the underlying asset
- The spot price adjusted for carrying costs over the contract period (Correct answer)
- Market consensus of future supply and demand
- The average of bid and ask prices for the underlying
Correct answer: The spot price adjusted for carrying costs over the contract period
Forward price = Spot price × e^(r×T) (or spot + cost of carry), reflecting financing costs and any income from the asset over the holding period.
Question 3: A company is exposed to declining oil prices on its inventory. Which derivative position best hedges this price risk?
- Buy oil futures
- Sell oil futures (Correct answer)
- Buy call options on oil
- Enter a fixed-for-floating oil swap as the floating receiver
Correct answer: Sell oil futures
Selling oil futures locks in a sale price, offsetting losses on physical inventory if oil prices fall.
Question 4: What is 'implied volatility' in options pricing?
- The historical standard deviation of the underlying's returns over the past year
- The volatility level that, when input into a pricing model, produces the current market option price (Correct answer)
- The expected range of the underlying price at expiry
- The volatility embedded in the underlying's futures contract
Correct answer: The volatility level that, when input into a pricing model, produces the current market option price
Implied volatility is derived by solving the option pricing model in reverse — it reflects the market's collective expectation of future volatility.
Question 5: What risk does a short futures position expose the holder to if the underlying price rises sharply?
- Opportunity cost only; no cash outflow occurs
- Unlimited loss potential, as losses are marked to market daily (Correct answer)
- Loss capped at the initial margin deposited
- Loss limited to the notional value of the contract
Correct answer: Unlimited loss potential, as losses are marked to market daily
Short futures positions are marked to market daily, and rising prices generate variation margin calls with theoretically unlimited loss potential.
Question 6: A collar strategy on a long stock position involves:
- Buying a put and selling a call, both out-of-the-money, on the same stock (Correct answer)
- Buying a call and selling a put at the same strike on the same stock
- Selling both a put and a call at the same strike to collect premium
- Buying a call spread above the current stock price
Correct answer: Buying a put and selling a call, both out-of-the-money, on the same stock
A collar limits downside via a long put and funds part of its cost by capping upside through a short call, creating a bracketed return range.
Question 7: In Canadian futures markets, what is the purpose of 'variation margin'?
- A one-time deposit required to open a futures position
- Daily cash settlements to reflect gains or losses from price changes (Correct answer)
- Collateral held by the broker against potential defaults
- A fee charged by the exchange on each contract traded
Correct answer: Daily cash settlements to reflect gains or losses from price changes
Variation margin is the daily cash flow resulting from mark-to-market settlement, crediting gains or debiting losses to each account.
CSC Derivatives and Risk Management 4
Which of the following describes a 'straddle' options strategy?