Option Trading Strategies

Question 1

The most important psychological aspect of trading is your ability to:

a) visualize the potential profit in a trade
b) know where to take profit on a winning trade
c) know your ability to handle risk
d) only a and c

Answer 1

c) know your ability to handle risk

Question 2

Selling naked options:

a) gives the seller obligations but no rights
b) has unlimited risk and limited reward
c) has led to the demise of many traders
d) all of the above

Answer 2

d) all of the above

Question 3

Selling naked options:

a) gives the seller a credit
b) limits reward but not risk
c) has limited risk for experienced traders
d) a and b only

Answer 3

d) a and b only

Question 4

Why did Long-Term Capital collapse?

a) It sold air.
b) The option model it used was outdated.
c) The collapse of the Russian currency could not be factored in.
d) It did not collapse; it was too big to fail.

Answer 4

a) It sold air.

Question 5

Buying a call to open:

a) has premium risk in addition to market risk
b) is a poor trading strategy
c) has defined risk and reward
d) both a and c

Answer 5

a) has premium risk in addition to market risk

Question 6

Call buyers have:

a) assignment risk
b) exercise rights
c) rights but no obligations
d) both b and c

Answer 6

d) both b and c

Question 7

A credit spread:

a) sells air and therefore has unlimited risk
b) has little upside in relation to its risk
c) is selling one option and buying another
d) both a and b

Answer 7

c) is selling one option and buying another

Question 8

A call credit spread is initiated by:

a) selling a call nearer to the ATM and buying an in-the-money call
b) buying a call that is out of the money and selling a call in the money
c) selling any call and buying a call at another strike
d) selling the ATM call and buying any other call

Answer 8

b) buying a call that is out of the money and selling a call in the money

Question 9

What is true about a put credit spread?

a) It has different rewards than a call credit spread.
b) It is the mirror image of a call credit spread.
c) It is initiated by buying one option and selling another.
d) Both b and c are true.

Answer 9

d) Both b and c are true.

Question 10

Calculating the potential profit in a credit spread:

a) can be done through the formula for conversions and reversals
b) is the difference between the credit and the strikes involved
c) is limited to the credit after the trade is completed
d) all of the above

Answer 10

d) all of the above

Question 11

The conversion and reversal formula allows a trader to do what?

a) tell how much of an ITM put is intrinsic
b) tell how much of an ITM call is air
c) compute where the underlying price should be
d) all of the above

Answer 11

d) all of the above

Question 12

The amount of premium in any strike in the same serial:

a) is constant and will be the same in a put as well as a call
b) can vary, depending on what option model is being traded
c) can’t be calculated until expiration
d) both a and c

Answer 12

a) is constant and will be the same in a put as well as a call

Question 13

Which of the following is true about conversions and reversals?

a) Trades that market makers use to take advantage of temporary price
dislocation.
b) They are riskless when executed correctly.
c) They should not be attempted by retail traders.
d) All of the above are true.

Answer 13

d) All of the above are true.

Question 14

On expiration Friday, the ATM call:

a) will have the same air as the ATM put
b) may have no premium at all since the risk is now known
c) should not be traded because of uncertainty
d) will have no value after expiration

Answer 14

a) will have the same air as the ATM put

Question 15

Why is it generally good to buy teenies to initiate a position?

a) They are worth a cheap shot and pay big dividends when they hit.
b) They offer a trade with very little time decay.
c) They will hold their value until the final day of trading.
d) None of the above; buying teenies to open is a losing trade on average.

Answer 15

d) None of the above; buying teenies to open is a losing trade on average.

Question 16

Buying deep ITM puts:

a) will initially mimic the underlying stock
b) will limit the amount of exposure to time decay
c) will eventually turn into a short stock position
d) only a and b

Answer 16

d) only a and b

Question 17

Debit spreads can:

a) have a reward greater than any credit spread
b) be cashed if there is no price movement
c) have unlimited reward once the debit is paid for by price movement
d) none of the above

Answer 17

d) none of the above

Question 18

When can a bear vertical ATM spread be cashed?

a) if price goes lower
b) if price goes higher
c) if price remains the same
d) all of the above

Answer 18

d) all of the above

Question 19

A 60/40 credit spread has:

a) theta risk if the price remains constant to expiration
b) more potential profit than an ATM bear credit spread
c) more potential loss than an ATM bull credit spread
d) only b and c

Answer 19

d) only b and c

Question 20

What limits the credit spread risk?

a) It has no limit, as you are selling air.
b) It is limited to the difference between the strikes used in the spread.
c) It has no limit on reward.
d) It is limited to the difference between the strikes used minus the credit.

Answer 20

d) It is limited to the difference between the strikes used minus the credit.

Question 21

Which of the following is true about pure risk reversal?

a) It is buying or selling the underlying asset synthetically.
b) There is both unlimited risk and unlimited reward.
c) It has no theta risk.
d) All of the above are true.

Answer 21

d) All of the above are true.

Question 22

An ITM risk reversal needs to:

a) buy an additional OTM option to limit the risk
b) have a small theta risk
c) have unlimited reward
d) all of the above

Answer 22

d) all of the above

Question 23

A put and call risk reversal share which of these traits?

a) Nothing; one is a synthetic put and one is a synthetic call.
b) They are mirror images.
c) They have unlimited reward to the short side of the trade.
d) They have no price risk.

Answer 23

b) They are mirror images.

Question 24

A backspread shares which of these traits with a risk reversal?

a) It has an extra-long option for protection.
b) It has unlimited reward.
c) It has limited risk.
d) All of the above are shared traits.

Answer 24

d) All of the above are shared traits.

Question 25

What is true about a 1 × 2 backspread?

a) It has little theta risk.
b) It is subject to expiration risk.
c) It has unlimited reward.
d) All of the above are true.

Answer 25

d) All of the above are true.