Stock Trading Stock Trading Options & Derivatives 2 — Questions and Answers
Question 1: A covered call strategy involves:
- Buying a call option while simultaneously buying the underlying stock
- Selling a call option against shares of the underlying stock you already own (Correct answer)
- Buying a put option to hedge a long stock position
- Selling both a call and a put on the same underlying stock
Correct answer: Selling a call option against shares of the underlying stock you already own
A covered call is written (sold) against an existing long stock position, generating premium income while capping potential upside above the strike price.
Question 2: A protective put is best described as:
- Selling a put option to collect premium income on a stock you own
- Buying a put option on a stock you already hold to limit downside risk (Correct answer)
- Buying shares of stock while simultaneously selling a put below market price
- Writing a put option on a stock you wish to acquire at a lower price
Correct answer: Buying a put option on a stock you already hold to limit downside risk
A protective put acts as insurance: the investor owns the stock for upside exposure but holds a put to limit losses if the stock declines below the strike price.
Question 3: Which options strategy profits when a stock makes a large move in either direction?
- Covered call
- Bull call spread
- Long straddle (Correct answer)
- Cash-secured put
Correct answer: Long straddle
A long straddle involves buying both a call and a put at the same strike and expiration, profiting from significant price movement in either direction.
Question 4: Delta in options trading measures:
- How much an option's price changes per one-point move in the underlying asset (Correct answer)
- The rate at which an option loses value over time
- The sensitivity of an option's price to changes in implied volatility
- The probability that an option will expire worthless
Correct answer: How much an option's price changes per one-point move in the underlying asset
Delta quantifies how much an option's price changes for each $1 move in the underlying stock; call deltas range from 0 to +1 and put deltas from -1 to 0.
Question 5: An iron condor options strategy profits when:
- The underlying stock makes a very large move up or down
- The underlying stock remains within a defined price range until expiration (Correct answer)
- Implied volatility rises sharply before expiration
- The stock reaches exactly one of the short strikes at expiration
Correct answer: The underlying stock remains within a defined price range until expiration
An iron condor combines a short call spread and a short put spread, collecting premium and profiting when the stock stays within the range defined by the inner short strikes.
Question 6: Implied volatility (IV) in options pricing represents:
- The historical standard deviation of the underlying stock's price over the past year
- The market's expectation of future price volatility embedded in option prices (Correct answer)
- The guaranteed range within which the stock will trade at expiration
- The annualized return of the underlying stock based on its price history
Correct answer: The market's expectation of future price volatility embedded in option prices
Implied volatility is a forward-looking metric derived from current option prices that reflects the market's consensus expectation of how much the stock will move.
Question 7: A bull call spread involves:
- Buying a lower-strike call and selling a higher-strike call with the same expiration (Correct answer)
- Buying two calls at the same strike to double directional exposure
- Selling a call and buying a put to profit from a decline
- Buying a call and simultaneously buying the underlying stock
Correct answer: Buying a lower-strike call and selling a higher-strike call with the same expiration
A bull call spread reduces the cost of a long call by selling a higher-strike call, limiting both maximum profit (capped at the short strike) and maximum loss (capped at net premium paid).
Stock Trading Stock Trading Options & Derivatives 2
A covered call strategy involves: