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
B. II, III
C. I, II
D. III, IV
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.