Options Strategies
Chapter: 5.4 Options Strategies Level: 1 — Recognition Time Limit: 20 minutes Total Marks: 30
Section A — Multiple Choice (1 mark each)
Q1. A covered call is constructed by:
- (a) Buying stock + buying a call
- (b) Buying stock + selling a call
- (c) Selling stock + selling a call
- (d) Buying a put + selling a call
Q2. A protective put is best described as:
- (a) Insurance on a long stock position
- (b) A pure income strategy with unlimited risk
- (c) Selling a put to collect premium
- (d) A strategy that profits only if stock is flat
Q3. A bull call spread involves:
- (a) Buying a lower-strike call and selling a higher-strike call
- (b) Selling a lower-strike call and buying a higher-strike call
- (c) Buying two calls at the same strike
- (d) Buying a call and buying a put
Q4. Which strategy is a net credit strategy expressing a bullish view?
- (a) Bull call spread
- (b) Bull put spread
- (c) Bear put spread
- (d) Long straddle
Q5. A long straddle profits most when:
- (a) The stock stays exactly at the strike
- (b) The stock makes a large move in either direction
- (c) Implied volatility collapses
- (d) The stock drifts slowly upward
Q6. The maximum loss of a long straddle is:
- (a) Unlimited
- (b) The total premium paid
- (c) The strike price
- (d) Zero
Q7. An iron condor is composed of:
- (a) A bull put spread + a bear call spread
- (b) A long call + long put at the same strike
- (c) Two long straddles
- (d) A covered call + protective put
Q8. An iron butterfly differs from an iron condor in that it:
- (a) Uses four different strikes evenly spaced
- (b) Sells the call and put at the same (ATM) strike
- (c) Has unlimited profit
- (d) Is a net debit strategy
Q9. A calendar spread is created by:
- (a) Buying and selling options of the same expiry, different strikes
- (b) Selling a near-term and buying a longer-term option of the same strike
- (c) Buying two options of different strikes and expiries
- (d) Selling stock and buying a call
Q10. A collar is typically used to:
- (a) Speculate on a big move
- (b) Protect a long stock position at low/zero net cost
- (c) Generate unlimited upside
- (d) Bet on rising volatility
Q11. Which strategy benefits from rising implied volatility?
- (a) Short strangle
- (b) Iron condor
- (c) Long strangle
- (d) Covered call
Q12. A short straddle has:
- (a) Limited profit, unlimited/large risk
- (b) Unlimited profit, limited risk
- (c) Limited profit, limited risk
- (d) No risk
Section B — Matching (1 mark each, 6 marks)
Q13. Match each strategy (left) to its defining feature (right).
| # | Strategy | Feature | |
|---|---|---|---|
| A | Bear put spread | 1 | Sell OTM call above long stock |
| B | Ratio spread | 2 | Buy higher-strike put, sell lower-strike put |
| C | Covered call | 3 | Unequal number of long vs short options |
| D | Iron condor | 4 | Two credit spreads, defined risk, range-bound view |
| E | Long strangle | 5 | Buy OTM call + buy OTM put, different strikes |
| F | Collar | 6 | Long stock + long put + short call |
Section C — True / False WITH Justification (2 marks each: 1 answer + 1 justification)
Q14. A protective put caps the upside profit of the underlying stock. True / False — justify.
Q15. A bull put spread reaches maximum profit when the stock closes above the higher (short) strike at expiry. True / False — justify.
Q16. A long strangle is generally cheaper to establish than a long straddle at the same expiry. True / False — justify.
Q17. In a diagonal spread, the two legs share the same strike price. True / False — justify.
Q18. When your view is neutral and implied volatility is HIGH, selling premium (e.g., iron condor) is preferred over buying a straddle. True / False — justify.
Q19. A bear call spread is a net-debit strategy. True / False — justify.
Q20. A covered call's maximum profit is limited to (strike − stock purchase price) + premium received. True / False — justify.
Answer keyMark scheme & solutions
Section A (12 marks)
Q1 — (b) Buy stock + sell a call. Why: You "cover" the sold call with owned shares, capping upside for premium. (1)
Q2 — (a) Insurance on long stock. Why: Long put sets a floor below the stock; downside is limited. (1)
Q3 — (a) Buy lower strike, sell higher strike call — net debit, bullish, defined risk/reward. (1)
Q4 — (b) Bull put spread — sell higher-strike put, buy lower-strike put → net credit, bullish. (1)
Q5 — (b) Large move either way; the strategy is long volatility/gamma. (1)
Q6 — (b) Total premium paid — worst case both options expire worthless at strike. (1)
Q7 — (a) Iron condor = bull put spread + bear call spread (four legs, two credit spreads). (1)
Q8 — (b) Sells ATM call and put at the same strike (body), with protective wings. (1)
Q9 — (b) Same strike, sell near-term, buy longer-term → profits from time decay differential. (1)
Q10 — (b) Protects long stock cheaply: short call finances the protective put. (1)
Q11 — (c) Long strangle — long options gain value as IV rises (positive vega). (1)
Q12 — (a) Limited profit (premium collected), large/unlimited risk. (1)
Section B (6 marks)
Q13: A–2, B–3, C–6, D–4, E–5, F–1. (1 each) Why: Bear put = buy higher/sell lower put (2); ratio = unequal legs (3); covered call = stock+short call (6); iron condor = two credit spreads range view (4); strangle = OTM call+put diff strikes (5); collar = stock + long put + short call → matches "sell OTM call above stock" combined with protection (1).
Section C (14 marks)
Q14 — FALSE. (1) Justification: A protective put keeps upside open (stock can rise indefinitely, minus put cost); it caps downside, not upside. (1)
Q15 — TRUE. (1) Justification: Both puts expire worthless above the short (higher) strike, so seller keeps the full net credit = max profit. (1)
Q16 — TRUE. (1) Justification: Strangle uses OTM options (cheaper) vs straddle's ATM options, so lower total premium/debit. (1)
Q17 — FALSE. (1) Justification: Diagonal spread differs in both strike and expiry; same-strike different-expiry is a calendar. (1)
Q18 — TRUE. (1) Justification: High IV = expensive options + neutral view favors selling premium; iron condor collects rich credit and profits from range + IV contraction. (1)
Q19 — FALSE. (1) Justification: Bear call spread sells the lower-strike (pricier) call and buys higher-strike → net credit, not debit. (1)
Q20 — TRUE. (1) Justification: Upside gain caps at the short strike; total profit = (K − purchase price) + premium; above K, called-away gains offset stock. (1)
Worked numeric illustrations (for verification)
- Covered call: buy stock @100, sell call K=105 for premium 2. Max profit = (105−100)+2 = 7.
- Bull call spread: buy 100 call @4, sell 110 call @1.5, debit = 2.5. Max profit = (110−100)−2.5 = 7.5; max loss = 2.5.
- Long straddle: buy 100 call @3 + 100 put @3, debit = 6. Max loss = 6; upper breakeven = 100+6 = 106, lower = 94.
- Bull put spread: sell 105 put @3, buy 100 put @1, credit = 2. Max profit = 2; max loss = (105−100)−2 = 3.
[
{"claim":"Covered call max profit = (105-100)+2 = 7","code":"K=105; buy=100; prem=2; maxp=(K-buy)+prem; result=(maxp==7)"},
{"claim":"Bull call spread max profit 7.5 and max loss 2.5","code":"debit=4-1.5; maxp=(110-100)-debit; maxl=debit; result=(maxp==7.5 and maxl==2.5)"},
{"claim":"Long straddle max loss 6, breakevens 106 and 94","code":"deb=3+3; up=100+deb; dn=100-deb; result=(deb==6 and up==106 and dn==94)"},
{"claim":"Bull put spread max profit 2 and max loss 3","code":"credit=3-1; maxp=credit; maxl=(105-100)-credit; result=(maxp==2 and maxl==3)"}
]