Level 2 — RecallOptions Strategies

Options Strategies

⏱ 30 minutes50 marksprintable — key stays hidden on paper

Chapter: 5.4 Options Strategies Level: 2 — Recall & Standard Problems Time Limit: 30 minutes Total Marks: 50

Instructions: Show all working. Use $...$ notation for calculations. All premiums and prices are in currency units per share unless stated otherwise.

Q1. Define a covered call strategy. State the market outlook of a trader who uses it and write the formula for the maximum profit. (4 marks)

Q2. A trader buys a stock at $\$ 100 $and buys a protective put with strike$ $95 $paying a premium of$ $3$. (a) Write the expression for the maximum loss. (b) Compute the maximum loss. (c) State the breakeven price. (6 marks)

Q3. A bull call spread is constructed by buying a call at strike $\$ 50 $(premium$ $4 $) and selling a call at strike$ $60 $(premium$ $1.5$). (a) Compute the net debit. (b) Compute the maximum profit. (c) Compute the breakeven price. (6 marks)

Q4. Distinguish between a bull put spread and a bear call spread in terms of: (i) whether they are net credit or net debit, and (ii) the directional view of the trader. (4 marks)

Q5. A long straddle is set up by buying a call and a put, both at strike $\$ 200 $, for premiums$ $6 $and$ $5$ respectively. (a) State the total cost. (b) Compute both breakeven points. (c) State the market condition under which this strategy profits. (6 marks)

Q6. Explain the key difference between a long straddle and a long strangle with respect to strike selection and cost. (4 marks)

Q7. An iron condor is built by selling a put spread and a call spread. A trader receives a net credit of $\$ 2 $on an iron condor with the short strikes at$ $90 $(put) and$ $110 $(call), and the wing width is$ $5$ on each side. (a) Compute the maximum profit. (b) Compute the maximum loss. (c) State both breakeven points. (6 marks)

Q8. Define an iron butterfly. How does it differ structurally from an iron condor? (4 marks)

Q9. Briefly explain a collar strategy and state the primary reason a long-stock holder would use it. (4 marks)

Q10. For each of the following views, name ONE appropriate strategy: (a) Neutral view with high implied volatility (expecting IV to fall). (b) Neutral view with low implied volatility (expecting a big move). (c) Moderately bullish, wanting limited cost. (d) Long stock, wanting protection at near-zero net cost. (4 marks)

Answer keyMark scheme & solutions

Q1. (4 marks)

Definition: A covered call = holding (long) the underlying stock while selling (writing) a call option against it. (2)
Outlook: Neutral to mildly bullish; expects the stock to stay flat or rise slightly. (1)
Max profit: $(\text{Strike} - \text{Purchase price}) + \text{Premium received}$ . (1)

Q2. (6 marks) Long stock at $100$ , long put at $95$ , premium $3$ .

(a) Max loss $= (\text{Stock price} - \text{Put strike}) + \text{Premium} = (100-95)+3$ . (2)
(b) $= 5 + 3 = \$ 8 $. **(2)** *(Below$ 95 $the put caps downside; loss =$ 5 $drop +$ 3$ premium.)*
(c) Breakeven $= \text{Stock price} + \text{Premium} = 100 + 3 = \$ 103$. (2)

Q3. (6 marks)

(a) Net debit $= 4 - 1.5 = \$ 2.5$. (2)
(b) Max profit $= (\text{Strike diff}) - \text{Net debit} = (60-50) - 2.5 = \$ 7.5$. (2)
(c) Breakeven $= \text{Lower strike} + \text{Net debit} = 50 + 2.5 = \$ 52.5$. (2)

Q4. (4 marks)

Bull put spread: Net credit; sell higher-strike put, buy lower-strike put; bullish view (profits if price stays above short strike). (2)
Bear call spread: Net credit; sell lower-strike call, buy higher-strike call; bearish view (profits if price stays below short strike). (2)

Q5. (6 marks)

(a) Total cost $= 6 + 5 = \$ 11$. (2)
(b) Upper BE $= 200 + 11 = \$ 211 $; Lower BE$ = 200 - 11 = $189$. (2)
(c) Profits on a large move in either direction (high realized volatility); the move must exceed total premium. (2)

Q6. (4 marks)

Long straddle: call and put at the same (ATM) strike; higher premium cost. (2)
Long strangle: call and put at different OTM strikes (call above, put below spot); cheaper, but needs a larger move to profit. (2)

Q7. (6 marks) Net credit $2$ , short strikes $90/110$ , wing width $5$ .

(a) Max profit $= \text{Net credit} = \$ 2 $(kept if price stays between$ 90 $and$ 110$). (2)
(b) Max loss $= \text{Wing width} - \text{Net credit} = 5 - 2 = \$ 3$. (2)
(c) Lower BE $= 90 - 2 = \$ 88 $; Upper BE$ = 110 + 2 = $112$. (2)

Q8. (4 marks)

Iron butterfly: sell an ATM call and ATM put (same strike) and buy protective OTM wings — combining a short straddle with long wings. (2)
Difference: iron condor's short call and short put are at different strikes (wider profit zone, lower credit); iron butterfly's shorts are at the same strike (narrow profit zone, higher credit). (2)

Q9. (4 marks)

Collar: hold long stock + buy a protective put + sell an OTM call to finance it. (2)
Reason: protects downside on the stock at little or zero net cost (call premium offsets put cost), capping both loss and gain. (2)

Q10. (4 marks — 1 each)

(a) Short straddle / short strangle / iron condor / iron butterfly (any credit, neutral, sell-vol strategy). (1)
(b) Long straddle / long strangle. (1)
(c) Bull call spread (or bull put spread). (1)
(d) Collar. (1)

[
  {"claim":"Q2 max loss = 8 and breakeven = 103","code":"stock=100; strike=95; prem=3; maxloss=(stock-strike)+prem; be=stock+prem; result=(maxloss==8 and be==103)"},
  {"claim":"Q3 net debit 2.5, max profit 7.5, breakeven 52.5","code":"debit=4-1.5; maxp=(60-50)-debit; be=50+debit; result=(debit==2.5 and maxp==7.5 and be==52.5)"},
  {"claim":"Q5 straddle cost 11, breakevens 211 and 189","code":"cost=6+5; up=200+cost; dn=200-cost; result=(cost==11 and up==211 and dn==189)"},
  {"claim":"Q7 iron condor max profit 2, max loss 3, BEs 88 and 112","code":"credit=2; width=5; maxp=credit; maxl=width-credit; lbe=90-credit; ube=110+credit; result=(maxp==2 and maxl==3 and lbe==88 and ube==112)"}
]