FINRA FINRA Options and Derivatives 2 — Questions and Answers
Question 1: What is a 'covered call' strategy?
- Selling a call option while owning the underlying stock (Correct answer)
- Buying a call option against a short stock position
- Selling a call and a put simultaneously on the same stock
- Buying a call option without owning the underlying stock
Correct answer: Selling a call option while owning the underlying stock
A covered call involves selling (writing) a call option on a stock the investor already owns, generating premium income in exchange for capping upside potential.
Question 2: What is a 'protective put' strategy?
- Buying a put option on stock already owned to limit downside risk (Correct answer)
- Selling a put option to collect premium on owned stock
- Buying puts on a stock you have sold short
- Writing puts against a diversified portfolio
Correct answer: Buying a put option on stock already owned to limit downside risk
A protective put involves buying a put on stock you own, functioning like insurance that limits losses if the stock price declines below the strike price.
Question 3: Which of the following best describes an options 'straddle'?
- Simultaneously buying a call and a put with the same strike price and expiration (Correct answer)
- Buying a call at one strike and a put at a different strike
- Selling both a call and a put with the same terms
- Buying two calls at different expiration dates
Correct answer: Simultaneously buying a call and a put with the same strike price and expiration
A long straddle involves purchasing both a call and a put with identical strike prices and expiration dates, profiting from significant price movement in either direction.
Question 4: What does 'time decay' (theta) mean in options pricing?
- The erosion of an option's time value as expiration approaches (Correct answer)
- The increase in option value as the stock price rises
- The decline in the option's delta over time
- The reduction in implied volatility before earnings
Correct answer: The erosion of an option's time value as expiration approaches
Theta represents the rate at which an option loses time value as it approaches expiration, with decay accelerating in the final weeks before expiry.
Question 5: FINRA Rule 2360 governs transactions in which type of securities?
- Options (Correct answer)
- Municipal bonds
- Mutual funds
- Variable annuities
Correct answer: Options
FINRA Rule 2360 (Options) establishes conduct standards, account requirements, approval procedures, and supervisory obligations for options transactions.
Question 6: Before a customer may trade options, a firm must ensure the account has been:
- Approved for options trading based on suitability information (Correct answer)
- Open for at least six months with a margin agreement
- Funded with a minimum of $10,000 in cash
- Reviewed by the exchange where options will be traded
Correct answer: Approved for options trading based on suitability information
Under FINRA Rule 2360, firms must collect suitability information and formally approve customer accounts for options trading before any transactions occur.
FINRA FINRA Options and Derivatives 2
What is a 'covered call' strategy?