Saturday, February 13, 2010

A twisted spread

I was listening to the playback of yesterday's Friday Free Broadcast on Straddles, Spreads, and Combinations, and I realized how hard a guy could make an options question on the Series 7 concerning any of these topics. With that in mind, let's see how twisted a question on option spreads could actually get on the Series 7:

Joe E. Investor buys an ABC Apr 45 put, writing an ABC Apr 50 put. Which of the following is/are true of this position?
I. Joe will profit if the spread widens
II. Joe will profit if ABC drops below 45
III. Joe will establish this position at a net credit to his account
IV. Joe will profit if ABC rises to 50 or above

A. I
C. I, II

EXPLANATION: okay, let's see what can be eliminated. Widen vs. narrow has to do with whether Joe has a debit or a credit spread. Which put is worth more, the ability to sell stock at $50 or at $45? Obviously, the April 50 put is worth more. Since Joe sold that one, he has a credit spread. Credit = narrow, so eliminate anything with "I" in it. A, and C are gone. And, suddenly "III" is in your answer. And, you just determined that Joe has a credit, so there is no doubt that "III" is in your answer. All you have to do is eliminate "II" or "IV," and you're done. Choice "II" implies that Joe is bearish on ABC. Does that make sense? Is he "long-the-lower-strike"? Yes. So, it does not make sense, because this is a B-U-L-L spread. Choice "II" is eliminated, making the correct answer . . . d

Now quick, what is your middle name?
Sorry--it can get a little confusing, can't it? Notice how I approach every "Roman Numeral" question as if it's a chess game. I'm using logic to eliminate players until I get down to just one remainder. Don't deal with the A-B-C-D structure first. Take each Roman Numeral choice and try to decide if it's in, or if it's out. Then, eliminate the A-B-C-D choices accordingly. This is how you need to approach the Series 7. This is how you take away the upper hand and turn it back on the test itself.


  1. listen to a playback of the broadcast through Valentine's Day at

  2. FWIW, I remember this: if the long option is closer to CMV, it's a Debit spread. Conversely, if the short option is closer to CMV, it's a credit spread.
    So, 50 is 'closer' to where CMV must be, and that is the option sold: this is a credit spread.

  3. Not bad, Ric. As long as the question tells you what the CMV is, this will work. But, if it says the guy buys the Apr 50 call and sells the Apr 60 call, without giving the market value, would that method still work? BTW, you just taught me a new one: FWIW. Also the name of a Buffalo Springfield song sung by Stephen Stills, right?

  4. I reckon that, if the CMV is NOT given, then it (the CMV) is either higher than both put spreads, or lower than both call spreads. Seen a # of such questions, where the CMV is not given....
    Right, FWIW is a B.F. oldie. A well-known protest/anti-war tune, from the 60's.
    ...not bad, for a Dead-Head, Robert.