Series 7 Quiz: Apply Option Strategies
20 questions · exam conditions
0:00
Apply Option StrategiesQuestion 1 of 20

A client expecting low volatility in PQR stock, trading at $78, sells a PQR Oct 80 call for $3 and sells a PQR Oct 75 put for $2. What is the maximum gain for this position?

$200
$300
$500
Unlimited
← Back to quizzes

Series 7 Quiz

Series 7 Quiz: Apply Option Strategies

Practice Apply Option Strategies in Series 7 with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Apply Option Strategies, giving you a quick way to practice the rules, question types, and explanations that matter most for Series 7.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

A client expecting low volatility in PQR stock, trading at $78, sells a PQR Oct 80 call for $3 and sells a PQR Oct 75 put for $2. What is the maximum gain for this position?

  1. $200
  2. $300
  3. $500 (correct answer)
  4. Unlimited
Explanation: This is a short strangle. The maximum gain for any short option combination strategy (straddle or strangle) is the total premium received. The client received $300 for the call and $200 for the put, for a total maximum gain of $500. This is achieved if the stock price is between the strike prices ($75 and $80) at expiration.

Question 2

MNO is $62 after a guidance cut; a trader buys 1 MNO $60 call at $4.40 and 1 MNO $60 put at $2.90; what is the breakeven point for the straddle strategy?

  1. Upside $70.00 and downside $50.00, assuming breakevens must be outside recent trading range
  2. Upside $64.40 and downside $55.60, using only the call premium for breakevens
  3. Upside $62.90 and downside $57.10, using only the put premium for breakevens
  4. Upside $67.30 and downside $52.70, using total premium paid of $7.30 (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves buying a call and put at the $60 strike after a guidance cut, requiring the understanding of breakeven points post-negative news. The correct answer, choice A, is valid because it accurately represents the breakeven points by adding and subtracting the total premium of $7.30 from the strike price. A common mistake, illustrated by choice B, is misunderstanding premium aggregation, which occurs when only the call premium is used for both sides. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 3

In a choppy market, an investor buys 1 XYZ $50 call at $3.20 and 1 XYZ $50 put at $2.80; what is the breakeven point for the straddle strategy?

  1. Upside $55.00 and downside $45.00, using intrinsic value only at expiration
  2. Upside $53.20 and downside $46.80, subtracting only the call premium
  3. Upside $56.00 and downside $44.00, using total premium paid of $6.00 (correct answer)
  4. Upside $52.80 and downside $47.20, subtracting only the put premium
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves purchasing a call and put with the same $50 strike in a choppy market, requiring the understanding of breakeven calculations for a long straddle. The correct answer, choice A, is valid because it accurately represents the breakeven points by adding and subtracting the total premium of $6.00 from the strike price. A common mistake, illustrated by choice B, is misunderstanding the need for total premium, which occurs when only the call premium is subtracted for both breakevens. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 4

YZA is $95 with volatility skew; a trader buys 1 YZA $95 call at $4.75 and 1 YZA $95 put at $5.25; what is the breakeven point for the straddle strategy?

  1. Upside $110.00 and downside $80.00, doubling premiums to account for volatility risk
  2. Upside $99.75 and downside $90.25, using only the call premium of $4.75
  3. Upside $100.25 and downside $89.75, using only the put premium of $5.25
  4. Upside $105.00 and downside $85.00, using total premium paid of $10.00 (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves buying a call and put at the $95 strike with volatility skew, requiring the understanding of breakeven points when premiums differ. The correct answer, choice A, is valid because it accurately represents the breakeven points by adding and subtracting the total premium of $10.00 from the strike price. A common mistake, illustrated by choice B, is misunderstanding total debit, which occurs when only the call premium is used. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 5

Intel (INTC) trades at $43 after a weak outlook; the investor expects further downside with defined risk. They buy 1 INTC 45 put for $3.10 and sell 1 INTC 38 put for $1.05 (bear put spread; net debit $2.05). How does the bear put spread protect the investor in a declining market? (B/E $=45-2.05; max loss =2.05;maxgain=2.05; max gain =(7.00-2.05).)

  1. It benefits most if INTC rises, because both puts expire worthless and keep premium.
  2. It guarantees profit because one put will always have intrinsic value at expiration.
  3. It creates unlimited profit if INTC collapses, since the long put has no cap.
  4. It limits risk to $2.05 and profits if INTC falls below $42.95 at expiration. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bear put spread on INTC, requiring the understanding of risk limitation in declining markets. The correct answer, choice A, is valid because it accurately represents the capped risk at $2.05 with profits below $42.95. A common mistake, illustrated by choice C, is misunderstanding that profits are unlimited, which occurs when ignoring the short put's limiting effect. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 6

SPDR S&P 500 ETF (SPY) trades at $492 after a strong jobs report; the investor expects a modest further rise, not a breakout. They buy 1 SPY 490 call for $8.60 and sell 1 SPY 505 call for $3.10 (bull call spread; net debit $5.50). What is the maximum profit potential for the given bull call spread? (Max profit $=(505-490)-5.50.)

  1. $20.50 per share maximum profit, adding the strike width and the net debit.
  2. $15.00 per share maximum profit, because the spread width is the profit.
  3. $5.50 per share maximum profit, because debit spreads cannot profit beyond premium.
  4. $9.50 per share maximum profit, computed as $(15.00-5.50)$. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bull call spread on SPY, requiring the understanding of maximum profit in debit spreads. The correct answer, choice A, is valid because it accurately represents the maximum profit of $9.50 per share by subtracting the debit from the spread width. A common mistake, illustrated by choice B, is misunderstanding that profit equals the spread width, which occurs when ignoring the net cost. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 7

Netflix (NFLX) trades at $585 after guidance cuts; the investor expects continued decline but wants defined risk. They buy 1 NFLX 590 put for $18.20 and sell 1 NFLX 550 put for $7.10 (bear put spread; net debit $11.10). How does the bear put spread protect the investor in a declining market? (B/E $=590-11.10; max loss =11.10;maxgain=11.10; max gain =(40.00-11.10).)

  1. It guarantees a profit because one put will always be in-the-money at expiration.
  2. It provides unlimited downside profit because the long put has no profit cap.
  3. It limits risk to $11.10 and profits if NFLX drops below $578.90 by expiration. (correct answer)
  4. It benefits most in a rally, since both puts expire worthless and keep full premium.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bear put spread on NFLX, requiring the understanding of risk limitation in declining markets. The correct answer, choice A, is valid because it accurately represents the limited risk to $11.10 with profits below $578.90. A common mistake, illustrated by choice B, is misunderstanding that profits are unlimited, which occurs when disregarding the short put's cap. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 8

Coinbase (COIN) trades at $128 after a crypto selloff; the investor expects further downside with defined risk. They buy 1 COIN 130 put for $9.40 and sell 1 COIN 110 put for $3.20 (bear put spread; net debit $6.20). How does the bear put spread protect the investor in a declining market? (B/E $=130-6.20; max loss =6.20;maxgain=6.20; max gain =(20.00-6.20).)

  1. It is most profitable if COIN rallies above $130, because both puts expire worthless.
  2. It yields unlimited profit if COIN collapses, because long puts have no maximum gain.
  3. It eliminates risk because the short put fully offsets any loss on the long put.
  4. It limits loss to $6.20 and profits if COIN falls below $123.80 at expiration. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bear put spread on COIN, requiring the understanding of risk limitation in declining markets. The correct answer, choice A, is valid because it accurately represents the loss limited to $6.20 with profits below $123.80. A common mistake, illustrated by choice B, is misunderstanding that profits are unlimited, which occurs when overlooking the short put's role. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 9

Ahead of Apple (AAPL) earnings, shares trade at $185 in a high-volatility tape. An investor buys 1 AAPL 185 call for $6.20 and 1 AAPL 185 put for $5.80 (long straddle; total debit $12.00). Assuming expiration Friday, what is the breakeven point for the straddle strategy? (Upper B/E $=185+12; Lower B/E =185−12;maxloss=185-12; max loss =12.00 debit; profit if AAPL moves beyond either B/E; risk limited to premium paid.)

  1. Upper $185.00 and lower $185.00, because breakeven occurs at the strike price.
  2. Upper $191.00 and lower $179.00, because only the call premium sets breakevens.
  3. Upper $203.00 and lower $167.00, because premiums are doubled for two contracts.
  4. Upper $197.00 and lower $173.00, because total premium is $12.00 per share. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a long straddle on AAPL, requiring the understanding of breakeven points for volatility plays. The correct answer, choice A, is valid because it accurately represents the upper breakeven at $197 and lower at $173 by adding and subtracting the total premium from the strike price. A common mistake, illustrated by choice D, is misunderstanding that breakeven occurs at the strike price, which occurs when ignoring the premium cost in straddle calculations. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 10

Exxon Mobil (XOM) trades at $102 with oil prices stable; the investor wants extra income and is willing to sell near resistance. They own 100 XOM shares at $99 and write 1 XOM 105 call for $1.85 (covered call). What are the implications of the covered call strategy on portfolio income? (Premium $=1.85; upside capped above $105; B/E $=99-1.85.)

  1. It requires no stock ownership because a covered call is defined by selling a call.
  2. It adds income and removes all downside risk because the premium offsets stock losses.
  3. It increases upside potential because short calls amplify gains when stock rises.
  4. It adds $1.85 income but caps gains above $105 if shares are called away. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a covered call on XOM, requiring the understanding of income generation and upside caps. The correct answer, choice A, is valid because it accurately represents the $1.85 income with gains capped above $105. A common mistake, illustrated by choice B, is misunderstanding that downside risk is removed, which occurs when overvaluing the premium's protection. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 11

Coca-Cola (KO) trades at $60 in a slow, income-oriented market; the investor wants yield enhancement. They own 100 KO shares at $58 and write 1 KO 62.50 call for $0.95 (covered call). What are the implications of the covered call strategy on portfolio income? (Premium $=0.95; upside capped above $62.50; B/E $=58-0.95.)

  1. It eliminates downside risk because option premium fully hedges any stock decline.
  2. It adds income and creates unlimited upside because stock gains are not capped.
  3. It adds $0.95 income but limits upside above $62.50 if the shares are assigned. (correct answer)
  4. It is a bearish strategy because selling calls always profits only when stock falls.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a covered call on KO, requiring the understanding of income generation and upside caps. The correct answer, choice A, is valid because it accurately represents the $0.95 income with upside limited above $62.50. A common mistake, illustrated by choice C, is misunderstanding that upside is unlimited, which occurs when confusing covered calls with naked calls. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 12

Boeing (BA) trades at $198 with improving sentiment but persistent headline risk; the investor expects a moderate rise. They buy 1 BA 200 call for $7.40 and sell 1 BA 220 call for $2.60 (bull call spread; net debit $4.80). What is the maximum profit potential for the given bull call spread? (Max profit $=(220-200)-4.80.)

  1. $4.80 per share maximum profit, because the debit is the most you can make.
  2. $20.00 per share maximum profit, because the short call does not affect profits.
  3. $15.20 per share maximum profit, calculated as $(20.00-4.80)$. (correct answer)
  4. $24.80 per share maximum profit, adding spread width and the net premium paid.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bull call spread on BA, requiring the understanding of maximum profit in debit spreads. The correct answer, choice A, is valid because it accurately represents the maximum profit of $15.20 per share from the spread width minus debit. A common mistake, illustrated by choice B, is misunderstanding that profit is the full spread width, which occurs when neglecting the net debit. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 13

Tesla (TSLA) trades at $205 after a weak delivery report, and implied volatility is elevated. A trader anticipates further downside and buys a bear put spread: long 1 TSLA 210 put for $14.10 and short 1 TSLA 190 put for $6.40 (net debit $7.70). How does the bear put spread protect the investor in a declining market? (Max gain $=(210-190)-7.70; max loss =7.70;B/E=7.70; B/E =210-7.70.)

  1. It benefits most if TSLA rises above $210, because both puts expire worthless.
  2. It creates unlimited profit if TSLA collapses, because long puts have no cap.
  3. It eliminates all risk because the short put fully hedges the long put position.
  4. It limits downside risk to $7.70 while allowing profit if TSLA falls below $202.30. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bear put spread on TSLA, requiring the understanding of risk limitation in declining markets. The correct answer, choice A, is valid because it accurately represents the limited downside risk to $7.70 with profits below the breakeven of $202.30. A common mistake, illustrated by choice B, is misunderstanding that profits are unlimited, which occurs when overlooking the short put that caps gains. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 14

Salesforce (CRM) trades at $292 with mildly bullish sentiment; the investor expects a moderate rise into month-end. They buy 1 CRM 290 call for $10.20 and sell 1 CRM 310 call for $4.30 (bull call spread; net debit $5.90). What is the maximum profit potential for the given bull call spread? (Max profit $=(310-290)-5.90.)

  1. $5.90 per share maximum profit, because the net debit is the maximum return.
  2. $20.00 per share maximum profit, because the spread width is fully captured.
  3. $14.10 per share maximum profit, calculated as $(20.00-5.90)$. (correct answer)
  4. $25.90 per share maximum profit, adding the spread width and the net debit paid.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a bull call spread on CRM, requiring the understanding of maximum profit in debit spreads. The correct answer, choice A, is valid because it accurately represents the maximum profit of $14.10 per share from width minus debit. A common mistake, illustrated by choice B, is misunderstanding that profit is the full width, which occurs when omitting the net cost. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 15

Goldman Sachs (GS) trades at $390 ahead of a Fed decision; volatility is elevated and direction is uncertain. The investor buys a long straddle: 1 GS 390 call for $9.80 and 1 GS 390 put for $10.20 (total debit $20.00). In the scenario described, what is the breakeven point for the straddle strategy? (Upper B/E $=390+20; Lower B/E $=390-20.)

  1. Upper $390.00 and lower $390.00, because both options are at-the-money at initiation.
  2. Upper $399.80 and lower $379.80, because only the call premium determines breakevens.
  3. Upper $430.00 and lower $350.00, because straddles use twice the total premium.
  4. Upper $410.00 and lower $370.00, because total premium paid is $20.00 per share. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a long straddle on GS, requiring the understanding of breakeven points for volatility plays. The correct answer, choice A, is valid because it accurately represents the upper breakeven at $410 and lower at $370 using the total premium. A common mistake, illustrated by choice D, is misunderstanding that breakeven is at the strike, which occurs when omitting the cost of premiums. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 16

Chevron (CVX) trades at $154 ahead of OPEC headlines; volatility is elevated and direction uncertain. The investor buys a long straddle: 1 CVX 154 call for $4.10 and 1 CVX 154 put for $4.40 (total debit $8.50). In the scenario described, what is the breakeven point for the straddle strategy? (Upper B/E $=154+8.50; Lower B/E $=154-8.50.)

  1. Upper $154.00 and lower $154.00, because breakeven occurs at the strike for straddles.
  2. Upper $158.10 and lower $149.60, because each option premium sets a separate breakeven.
  3. Upper $171.00 and lower $137.00, because straddles require doubling the total premium.
  4. Upper $162.50 and lower $145.50, because total premium paid is $8.50 per share. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a long straddle on CVX, requiring the understanding of breakeven points for volatility plays. The correct answer, choice A, is valid because it accurately represents the upper breakeven at $162.50 and lower at $145.50 using total premium. A common mistake, illustrated by choice D, is misunderstanding that breakeven is at the strike, which occurs when ignoring debit impact. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 17

JPMorgan (JPM) trades at $176 ahead of bank earnings; volatility is elevated and direction is uncertain. The investor buys a long straddle: 1 JPM 176 call for $4.25 and 1 JPM 176 put for $4.05 (total debit $8.30). In the scenario described, what is the breakeven point for the straddle strategy? (Upper B/E $=176+8.30; Lower B/E $=176-8.30.)

  1. Upper $192.60 and lower $159.40, because breakevens require doubling the total debit.
  2. Upper $180.25 and lower $171.95, because breakevens use each premium independently.
  3. Upper $184.30 and lower $167.70, because total premium paid is $8.30 per share. (correct answer)
  4. Upper $176.00 and lower $176.00, because straddles break even at the strike price.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a long straddle on JPM, requiring the understanding of breakeven points for volatility plays. The correct answer, choice A, is valid because it accurately represents the upper breakeven at $184.30 and lower at $167.70 based on total premium. A common mistake, illustrated by choice D, is misunderstanding that breakeven is at the strike, which occurs when disregarding premium costs. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 18

NVIDIA (NVDA) trades at $625 in a range-bound market; the investor wants income but is willing to sell shares at a target price. They own 100 NVDA shares at $610 and write 1 NVDA 650 call for $9.50 (covered call). What are the implications of the covered call strategy on portfolio income? (Premium received $=9.50; upside capped above $650; downside risk similar to stock less premium; B/E $=610-9.50.)

  1. It creates unlimited upside because the investor holds stock and is short a call.
  2. It generates income and eliminates downside risk because the call premium guarantees protection.
  3. It generates $9.50 premium income but caps gains above $650 if the call is exercised. (correct answer)
  4. It requires margin like a naked call, because the short call is always uncovered.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves a covered call on NVDA, requiring the understanding of income generation and upside caps. The correct answer, choice A, is valid because it accurately represents the $9.50 premium income with gains capped above $650. A common mistake, illustrated by choice B, is misunderstanding that downside risk is eliminated, which occurs when overestimating the protective effect of the premium. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 19

Alphabet (GOOGL) trades at $152 after a strong quarter; implied volatility is low. A trader sells 1 GOOGL 160 call for $1.60 without owning shares (naked call) to collect premium. If GOOGL spikes on an AI product announcement, which statement accurately describes the risk involved in an uncovered call position? (B/E $=160+1.60; max loss unlimited; margin required.)

  1. Losses are limited to $160 because assignment forces purchase at the strike price.
  2. Losses are limited to $1.60 because option writers can only lose the premium received.
  3. Losses are theoretically unlimited above $161.60, and margin requirements can increase rapidly. (correct answer)
  4. Losses are capped by the call's strike width, similar to a vertical spread position.
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves an uncovered call on GOOGL, requiring the understanding of unlimited risk in naked positions. The correct answer, choice A, is valid because it accurately represents the unlimited losses above $161.60 with rising margin. A common mistake, illustrated by choice B, is misunderstanding that losses are limited to the premium, which occurs when confusing call writing with put writing. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.

Question 20

Amazon (AMZN) trades at $168 with low realized volatility; a trader sells 1 AMZN 175 call for $2.10 without owning the stock (uncovered call). If AMZN rallies sharply on a surprise buyback, which statement accurately describes the risk involved in an uncovered call position? (Premium received $=2.10; B/E $=175+2.10; max loss theoretically unlimited; margin required by broker/Reg T.)

  1. Risk is eliminated if AMZN stays below $175, since margin is not required on calls.
  2. Risk is limited to $2.10 because the premium received offsets any stock price increase.
  3. Risk is limited to the strike difference because uncovered calls behave like spreads.
  4. Risk is unlimited above $177.10, and the writer faces margin calls if AMZN rises. (correct answer)
Explanation: This question tests the understanding of applying option strategies including spreads, straddles, and covered/uncovered positions as part of Series 7 competencies. Option strategies are used to capitalize on market movements, manage risk, and enhance returns through positions like spreads and straddles. The specific scenario described involves an uncovered call on AMZN, requiring the understanding of unlimited risk in naked positions. The correct answer, choice A, is valid because it accurately represents the unlimited risk above $177.10 with potential margin calls. A common mistake, illustrated by choice B, is misunderstanding that risk is limited to the premium, which occurs when confusing writers' and buyers' risk profiles. To approach similar questions, candidates should practice calculating breakeven points and understanding the risk profiles of different option strategies, while also considering market conditions and investor objectives.