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Questions:
Derivatives Fundamentals and Options Licensing Course (DFOL) Quiz 06 Covered-
Derivative-Based ETFs-
Introduction
Commodity ETFs
Swap-Based ETFs and the Synthetic Replication of Indexes
Leveraged and Inverse ETFs
A Review of the Risk and Reward Profiles of Common Option Strategies –
Long Call
Married Put
Covered Call (also known as Covered Write)
A Review of the Risk and Reward Profiles of Common Option Strategies –
Put Writing
Benchmark Indexes for Income-Producing Option Strategies
A Brief Review of Spreads, Straddles and Combinations
A Review of the Risk and Reward Profiles of Common Option Strategies –
Bull Call Spread
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Mr. Thompson is a portfolio manager considering the use of over-the-counter options to enhance returns for the investment fund he manages. What is a potential disadvantage of using over-the-counter options in this context?
Explanation:
The correct answer is A. Liquidity risk. Over-the-counter options may carry liquidity risk, as these are traded directly between parties, and finding a willing counterparty can be challenging. Limited customization (Option B) is a potential advantage, as over-the-counter options can be tailored to specific needs. Transparent pricing (Option C) is associated with standardized exchange-traded options. Standardized contract terms (Option D) are a feature of exchange-traded options.
Relevant laws: In Canada, securities regulations govern the trading of derivatives and emphasize the need for fair and transparent markets.
Explanation:
The correct answer is A. Liquidity risk. Over-the-counter options may carry liquidity risk, as these are traded directly between parties, and finding a willing counterparty can be challenging. Limited customization (Option B) is a potential advantage, as over-the-counter options can be tailored to specific needs. Transparent pricing (Option C) is associated with standardized exchange-traded options. Standardized contract terms (Option D) are a feature of exchange-traded options.
Relevant laws: In Canada, securities regulations govern the trading of derivatives and emphasize the need for fair and transparent markets.
Mr. Adams is considering investing in a closed-end fund that employs alternative investment strategies. What is a key characteristic of closed-end funds compared to mutual funds?
Explanation:
The correct answer is B. Fixed number of shares. Closed-end funds issue a fixed number of shares through an initial public offering (IPO) and do not continuously issue or redeem shares like open-end mutual funds. Daily liquidity (Option A) is not guaranteed, as closed-end funds trade on stock exchanges. Management fees for closed-end funds (Option C) can vary and are not necessarily lower. Redemption at Net Asset Value (NAV) (Option D) is a characteristic of open-end mutual funds.
Relevant laws: Canadian securities regulations provide guidelines for the operation and disclosure requirements of closed-end funds.
Explanation:
The correct answer is B. Fixed number of shares. Closed-end funds issue a fixed number of shares through an initial public offering (IPO) and do not continuously issue or redeem shares like open-end mutual funds. Daily liquidity (Option A) is not guaranteed, as closed-end funds trade on stock exchanges. Management fees for closed-end funds (Option C) can vary and are not necessarily lower. Redemption at Net Asset Value (NAV) (Option D) is a characteristic of open-end mutual funds.
Relevant laws: Canadian securities regulations provide guidelines for the operation and disclosure requirements of closed-end funds.
In the context of hedge funds, what is a potential advantage of using derivatives for alternative investment strategies?
Explanation:
The correct answer is D. Enhanced return potential. Hedge funds often use derivatives to amplify returns and create sophisticated investment strategies. Simplified risk management (Option A) is not a typical characteristic, as derivatives can add complexity. Hedge funds are known for their flexibility in using leverage (Option B), contrary to the statement. The use of derivatives provides increased flexibility (Option C) in constructing unique investment approaches.
Relevant laws: Securities regulations in Canada provide exemptions for hedge funds but emphasize the need for effective risk management.
Explanation:
The correct answer is D. Enhanced return potential. Hedge funds often use derivatives to amplify returns and create sophisticated investment strategies. Simplified risk management (Option A) is not a typical characteristic, as derivatives can add complexity. Hedge funds are known for their flexibility in using leverage (Option B), contrary to the statement. The use of derivatives provides increased flexibility (Option C) in constructing unique investment approaches.
Relevant laws: Securities regulations in Canada provide exemptions for hedge funds but emphasize the need for effective risk management.
Ms. Foster is a financial advisor discussing alternative mutual funds with a client. The client is concerned about the lack of daily liquidity. What would be an appropriate explanation for Ms. Foster?
Explanation:
The correct answer is C. “Daily liquidity may be impacted as alternative mutual funds invest in less liquid assets.” Alternative mutual funds may invest in less liquid assets, impacting their ability to provide daily redemptions. Option A is incorrect, as daily redemptions are not guaranteed. Option B is incorrect, as liquidity is not guaranteed by regulatory requirements. Option D is incomplete and lacks an explanation.
Relevant laws: Canadian securities regulations guide the operation and disclosure requirements of alternative mutual funds.
Explanation:
The correct answer is C. “Daily liquidity may be impacted as alternative mutual funds invest in less liquid assets.” Alternative mutual funds may invest in less liquid assets, impacting their ability to provide daily redemptions. Option A is incorrect, as daily redemptions are not guaranteed. Option B is incorrect, as liquidity is not guaranteed by regulatory requirements. Option D is incomplete and lacks an explanation.
Relevant laws: Canadian securities regulations guide the operation and disclosure requirements of alternative mutual funds.
When considering the use of derivatives in alternative investment strategies, what is a potential disadvantage for investors?
Explanation:
The correct answer is C. Higher transaction costs. The use of derivatives can involve additional transaction costs, impacting overall returns for investors. Portfolio diversification (Option A) and increased transparency (Option B) are potential advantages of using derivatives. Lower risk exposure (Option D) is not typically associated with the use of derivatives, as they can introduce additional risk.
Relevant laws: Canadian securities regulations emphasize the need for fair and transparent markets when trading derivatives.
Explanation:
The correct answer is C. Higher transaction costs. The use of derivatives can involve additional transaction costs, impacting overall returns for investors. Portfolio diversification (Option A) and increased transparency (Option B) are potential advantages of using derivatives. Lower risk exposure (Option D) is not typically associated with the use of derivatives, as they can introduce additional risk.
Relevant laws: Canadian securities regulations emphasize the need for fair and transparent markets when trading derivatives.
Mrs. Anderson is considering investing in Over-the-Counter (OTC) options for her portfolio. What is a potential advantage of OTC options compared to exchange-traded options?
Explanation:
The correct answer is C. Tailored customization. OTC options offer the advantage of customization, allowing parties to negotiate terms that suit their specific needs. Standardized contract terms (Option A) are a feature of exchange-traded options. Centralized clearing (Option B) is a characteristic of exchange-traded options, providing transparency. High liquidity (Option D) is generally associated with exchange-traded options.
Relevant laws: In Canada, securities regulations oversee the trading of OTC derivatives, emphasizing transparency and fair practices.
Explanation:
The correct answer is C. Tailored customization. OTC options offer the advantage of customization, allowing parties to negotiate terms that suit their specific needs. Standardized contract terms (Option A) are a feature of exchange-traded options. Centralized clearing (Option B) is a characteristic of exchange-traded options, providing transparency. High liquidity (Option D) is generally associated with exchange-traded options.
Relevant laws: In Canada, securities regulations oversee the trading of OTC derivatives, emphasizing transparency and fair practices.
When engaging in OTC options trading, what is a key consideration for market participants in terms of counterparty risk?
Explanation:
The correct answer is B. Counterparty creditworthiness. In OTC options, market participants face counterparty risk, making it crucial to assess the creditworthiness of the involved parties. Centralized clearinghouse protection (Option A) is a feature of exchange-traded options. Standardized contract terms (Option C) are associated with exchange-traded options. High-frequency trading (Option D) is not directly related to counterparty risk.
Relevant laws: Canadian securities regulations stress the importance of due diligence in assessing counterparty risk in OTC derivatives transactions.
Explanation:
The correct answer is B. Counterparty creditworthiness. In OTC options, market participants face counterparty risk, making it crucial to assess the creditworthiness of the involved parties. Centralized clearinghouse protection (Option A) is a feature of exchange-traded options. Standardized contract terms (Option C) are associated with exchange-traded options. High-frequency trading (Option D) is not directly related to counterparty risk.
Relevant laws: Canadian securities regulations stress the importance of due diligence in assessing counterparty risk in OTC derivatives transactions.
Mr. Smith holds Principle Protected Notes (PPNs) and is concerned about the impact of market volatility on his investment. What characteristic of PPN structures helps mitigate this concern?
Explanation:
The correct answer is A. Fixed return. PPN structures often provide a fixed return, protecting investors from the impact of market fluctuations. Exposure to market fluctuations (Option B) is a concern for investors without principal protection. Lack of principal protection (Option C) would increase vulnerability to market volatility. High-risk profile (Option D) contradicts the principle of PPNs, which is to offer principal protection.
Relevant laws: Regulatory frameworks in Canada emphasize disclosure requirements for PPNs, ensuring investors are informed about the terms and risks.
Explanation:
The correct answer is A. Fixed return. PPN structures often provide a fixed return, protecting investors from the impact of market fluctuations. Exposure to market fluctuations (Option B) is a concern for investors without principal protection. Lack of principal protection (Option C) would increase vulnerability to market volatility. High-risk profile (Option D) contradicts the principle of PPNs, which is to offer principal protection.
Relevant laws: Regulatory frameworks in Canada emphasize disclosure requirements for PPNs, ensuring investors are informed about the terms and risks.
When comparing CPPI and Zero-Coupon Bond Plus Call Option Structures, what is a key difference relevant to investors?
Explanation:
The correct answer is C. Fixed maturity date. CPPI (Constant Proportion Portfolio Insurance) and Zero-Coupon Bond Plus Call Option Structures differ in their treatment of maturity dates. CPPI structures do not have a fixed maturity date, while Zero-Coupon Bond Plus Call Option Structures have a predetermined maturity date. Principal protection (Option A) is a common feature of both. Market exposure (Option B) varies based on the structure. Redemption at Net Asset Value (NAV) (Option D) is not directly related to the maturity date.
Relevant laws: Canadian securities regulations provide guidelines for the disclosure of terms and risks associated with structured products like CPPI and Zero-Coupon Bond Plus Call Option Structures.
Explanation:
The correct answer is C. Fixed maturity date. CPPI (Constant Proportion Portfolio Insurance) and Zero-Coupon Bond Plus Call Option Structures differ in their treatment of maturity dates. CPPI structures do not have a fixed maturity date, while Zero-Coupon Bond Plus Call Option Structures have a predetermined maturity date. Principal protection (Option A) is a common feature of both. Market exposure (Option B) varies based on the structure. Redemption at Net Asset Value (NAV) (Option D) is not directly related to the maturity date.
Relevant laws: Canadian securities regulations provide guidelines for the disclosure of terms and risks associated with structured products like CPPI and Zero-Coupon Bond Plus Call Option Structures.
In the context of OTC options, what is a potential disadvantage for investors related to transparency?
Explanation:
The correct answer is B. Counterparty anonymity. In OTC options, counterparty information may not be as transparent as in exchange-traded options, posing a potential disadvantage for investors. Standardized contract terms (Option A) are associated with exchange-traded options. Tailored customization (Option C) is a potential advantage of OTC options. Centralized clearing (Option D) is a characteristic of exchange-traded options, providing transparency.
Relevant laws: Canadian securities regulations emphasize transparency and fair practices in OTC derivatives transactions.
Explanation:
The correct answer is B. Counterparty anonymity. In OTC options, counterparty information may not be as transparent as in exchange-traded options, posing a potential disadvantage for investors. Standardized contract terms (Option A) are associated with exchange-traded options. Tailored customization (Option C) is a potential advantage of OTC options. Centralized clearing (Option D) is a characteristic of exchange-traded options, providing transparency.
Relevant laws: Canadian securities regulations emphasize transparency and fair practices in OTC derivatives transactions.
Mr. Thompson is considering investing in a Derivative-Based ETF that tracks the performance of a commodity index. What key feature differentiates Derivative-Based ETFs from traditional ETFs?
Explanation:
The correct answer is B. Use of derivatives contracts. Derivative-Based ETFs employ derivatives such as futures contracts to track the performance of underlying assets like commodity indices. Traditional ETFs (Option A) often achieve tracking through direct ownership. Fixed return structures (Option C) are not a typical feature of ETFs. Passive management strategy (Option D) is common in both traditional and derivative-based ETFs.
Relevant laws: Canadian securities regulations require disclosure of the use of derivatives in ETFs to ensure investors are informed about associated risks.
Explanation:
The correct answer is B. Use of derivatives contracts. Derivative-Based ETFs employ derivatives such as futures contracts to track the performance of underlying assets like commodity indices. Traditional ETFs (Option A) often achieve tracking through direct ownership. Fixed return structures (Option C) are not a typical feature of ETFs. Passive management strategy (Option D) is common in both traditional and derivative-based ETFs.
Relevant laws: Canadian securities regulations require disclosure of the use of derivatives in ETFs to ensure investors are informed about associated risks.
When investing in Commodity ETFs, what is a potential risk related to the tracking of commodity prices?
Explanation:
The correct answer is B. Leverage exposure. Commodity ETFs may use leverage to amplify returns, leading to increased risk and volatility. Diversification benefits (Option A) are associated with a well-constructed portfolio but not necessarily a risk in commodity ETFs. Guaranteed capital protection (Option C) contradicts the typical risk profile of commodity investments. Active management fees (Option D) are relevant to actively managed funds, not necessarily Commodity ETFs.
Relevant laws: Canadian securities regulations emphasize the disclosure of risks, including leverage, in investment products such as Commodity ETFs.
Explanation:
The correct answer is B. Leverage exposure. Commodity ETFs may use leverage to amplify returns, leading to increased risk and volatility. Diversification benefits (Option A) are associated with a well-constructed portfolio but not necessarily a risk in commodity ETFs. Guaranteed capital protection (Option C) contradicts the typical risk profile of commodity investments. Active management fees (Option D) are relevant to actively managed funds, not necessarily Commodity ETFs.
Relevant laws: Canadian securities regulations emphasize the disclosure of risks, including leverage, in investment products such as Commodity ETFs.
Ms. Davis is evaluating an investment in a Derivative-Based ETF that aims to replicate the performance of a commodity index. What factor might affect the tracking accuracy of this ETF?
Explanation:
The correct answer is B. Low trading volumes of the ETF. Low trading volumes can lead to wider bid-ask spreads and affect the tracking accuracy of Derivative-Based ETFs. High liquidity of the underlying commodities (Option A) is beneficial but not directly related to ETF trading volumes. Limited use of derivatives contracts (Option C) might impact tracking precision. Consistent dividends (Option D) are not a typical factor affecting tracking accuracy.
Relevant laws: Canadian securities regulations emphasize the importance of transparency and disclosure regarding tracking accuracy in ETFs.
Explanation:
The correct answer is B. Low trading volumes of the ETF. Low trading volumes can lead to wider bid-ask spreads and affect the tracking accuracy of Derivative-Based ETFs. High liquidity of the underlying commodities (Option A) is beneficial but not directly related to ETF trading volumes. Limited use of derivatives contracts (Option C) might impact tracking precision. Consistent dividends (Option D) are not a typical factor affecting tracking accuracy.
Relevant laws: Canadian securities regulations emphasize the importance of transparency and disclosure regarding tracking accuracy in ETFs.
What risk is associated with Derivative-Based ETFs that utilize swaps to replicate commodity index performance?
Explanation:
The correct answer is A. Counterparty risk. Derivative-Based ETFs using swaps expose investors to the risk of the counterparty defaulting on the swap agreement. Currency risk (Option B) is associated with fluctuations in exchange rates. Interest rate risk (Option C) pertains to changes in interest rates. Market price risk (Option D) is a general risk associated with the overall market.
Relevant laws: Canadian securities regulations stress the importance of disclosing counterparty risk in derivative-based investment products.
Explanation:
The correct answer is A. Counterparty risk. Derivative-Based ETFs using swaps expose investors to the risk of the counterparty defaulting on the swap agreement. Currency risk (Option B) is associated with fluctuations in exchange rates. Interest rate risk (Option C) pertains to changes in interest rates. Market price risk (Option D) is a general risk associated with the overall market.
Relevant laws: Canadian securities regulations stress the importance of disclosing counterparty risk in derivative-based investment products.
Mr. Harris is considering an investment in a Commodity ETF that tracks the performance of physical commodities. What is a potential advantage of investing in Commodity ETFs with direct physical ownership?
Explanation:
The correct answer is A. Reduced tracking error. Commodity ETFs with direct physical ownership can help reduce tracking error compared to those using derivatives, leading to a closer alignment with the performance of the underlying commodities. Leverage exposure (Option B) is a risk associated with some commodity ETFs. Increased liquidity (Option C) is not necessarily linked to direct physical ownership. Active management strategy (Option D) is typically associated with actively managed funds.
Relevant laws: Canadian securities regulations require disclosure of tracking methods and potential tracking errors in commodity ETFs.
Explanation:
The correct answer is A. Reduced tracking error. Commodity ETFs with direct physical ownership can help reduce tracking error compared to those using derivatives, leading to a closer alignment with the performance of the underlying commodities. Leverage exposure (Option B) is a risk associated with some commodity ETFs. Increased liquidity (Option C) is not necessarily linked to direct physical ownership. Active management strategy (Option D) is typically associated with actively managed funds.
Relevant laws: Canadian securities regulations require disclosure of tracking methods and potential tracking errors in commodity ETFs.
Mrs. Miller is considering investing in a Swap-Based ETF that synthetically replicates the performance of a stock index. What is a key characteristic of Swap-Based ETFs in terms of index replication?
Explanation:
The correct answer is B. Utilization of derivatives and swaps. Swap-Based ETFs achieve index replication through the use of derivatives, particularly swaps. Unlike traditional ETFs (Option A) that may directly own index components, Swap-Based ETFs use swaps to mimic index returns. Leverage restrictions (Option C) and daily rebalancing (Option D) are features associated with Leveraged and Inverse ETFs, not necessarily Swap-Based ETFs.
Relevant laws: Canadian securities regulations require clear disclosure of the use of derivatives, including swaps, in investment products like Swap-Based ETFs.
Explanation:
The correct answer is B. Utilization of derivatives and swaps. Swap-Based ETFs achieve index replication through the use of derivatives, particularly swaps. Unlike traditional ETFs (Option A) that may directly own index components, Swap-Based ETFs use swaps to mimic index returns. Leverage restrictions (Option C) and daily rebalancing (Option D) are features associated with Leveraged and Inverse ETFs, not necessarily Swap-Based ETFs.
Relevant laws: Canadian securities regulations require clear disclosure of the use of derivatives, including swaps, in investment products like Swap-Based ETFs.
What risk is associated with investing in Leveraged ETFs that aim to deliver returns equal to a multiple of the daily performance of an underlying index?
Explanation:
The correct answer is A. Tracking error risk. Leveraged ETFs aim to deliver daily returns equal to a multiple of the index performance, and over more extended periods, compounding may lead to tracking errors. Counterparty risk (Option B) is more relevant to products using derivatives. Interest rate risk (Option C) is not a significant factor in short-term leveraged strategies. Market timing risk (Option D) is more associated with investor behavior.
Relevant laws: Canadian securities regulations emphasize the importance of disclosing risks related to leverage and tracking error in investment products.
Explanation:
The correct answer is A. Tracking error risk. Leveraged ETFs aim to deliver daily returns equal to a multiple of the index performance, and over more extended periods, compounding may lead to tracking errors. Counterparty risk (Option B) is more relevant to products using derivatives. Interest rate risk (Option C) is not a significant factor in short-term leveraged strategies. Market timing risk (Option D) is more associated with investor behavior.
Relevant laws: Canadian securities regulations emphasize the importance of disclosing risks related to leverage and tracking error in investment products.
Mr. Anderson is interested in Inverse ETFs that aim to provide returns opposite to the daily performance of an index. What is a potential drawback of holding Inverse ETFs over an extended period?
Explanation:
The correct answer is B. Compounded returns. Inverse ETFs aim to provide daily returns opposite to the index, and over time, compounding can lead to returns significantly different from the index’s inverse. Lower volatility (Option A) may not necessarily be a drawback. Currency exchange risk (Option C) is not directly associated with Inverse ETFs. Tax advantages (Option D) might be a consideration but are not a drawback.
Relevant laws: Canadian securities regulations stress the importance of disclosing the risks and features of Inverse ETFs to investors.
Explanation:
The correct answer is B. Compounded returns. Inverse ETFs aim to provide daily returns opposite to the index, and over time, compounding can lead to returns significantly different from the index’s inverse. Lower volatility (Option A) may not necessarily be a drawback. Currency exchange risk (Option C) is not directly associated with Inverse ETFs. Tax advantages (Option D) might be a consideration but are not a drawback.
Relevant laws: Canadian securities regulations stress the importance of disclosing the risks and features of Inverse ETFs to investors.
What factor distinguishes Leveraged ETFs from traditional ETFs in terms of their investment strategy?
Explanation:
The correct answer is D. Magnified exposure through derivatives. Leveraged ETFs use derivatives such as swaps to achieve magnified exposure, allowing them to aim for returns equal to a multiple of the index’s daily performance. Active management (Option A) and the use of options contracts (Option B) are not unique to Leveraged ETFs. Portfolio diversification (Option C) is a common feature in traditional ETFs.
Relevant laws: Canadian securities regulations require clear disclosure of investment strategies, including the use of derivatives, in Leveraged ETFs.
Explanation:
The correct answer is D. Magnified exposure through derivatives. Leveraged ETFs use derivatives such as swaps to achieve magnified exposure, allowing them to aim for returns equal to a multiple of the index’s daily performance. Active management (Option A) and the use of options contracts (Option B) are not unique to Leveraged ETFs. Portfolio diversification (Option C) is a common feature in traditional ETFs.
Relevant laws: Canadian securities regulations require clear disclosure of investment strategies, including the use of derivatives, in Leveraged ETFs.
Mrs. Johnson is bullish on a stock and wants to benefit from potential upward price movement. Which option strategy would best suit her outlook?
Explanation:
The correct answer is C. Long Call. A Long Call strategy involves buying a call option to profit from a potential increase in the underlying stock’s price. This strategy provides leverage and unlimited upside potential. Short Put (Option A) is a strategy for investors expecting the stock to remain neutral or rise slightly. Covered Call (Option B) generates income but limits upside potential. Married Put (Option D) is a protective strategy and not suitable for a bullish outlook.
Relevant laws: Canadian securities regulations require clear disclosure of the risk and reward profiles associated with different option strategies.
Explanation:
The correct answer is C. Long Call. A Long Call strategy involves buying a call option to profit from a potential increase in the underlying stock’s price. This strategy provides leverage and unlimited upside potential. Short Put (Option A) is a strategy for investors expecting the stock to remain neutral or rise slightly. Covered Call (Option B) generates income but limits upside potential. Married Put (Option D) is a protective strategy and not suitable for a bullish outlook.
Relevant laws: Canadian securities regulations require clear disclosure of the risk and reward profiles associated with different option strategies.
What is a key risk associated with the Covered Call strategy?
Explanation:
The correct answer is B. Limited profit potential. Covered Call involves selling a call option against an existing stock position, capping potential profit at the strike price. Unlimited downside risk (Option A) is not applicable to the Covered Call strategy. Credit risk (Option C) is more associated with certain fixed-income investments. Margin calls (Option D) are typically not a concern with Covered Call.
Relevant laws: Canadian securities regulations emphasize the importance of explaining the risk and reward profiles of different option strategies to investors.
Explanation:
The correct answer is B. Limited profit potential. Covered Call involves selling a call option against an existing stock position, capping potential profit at the strike price. Unlimited downside risk (Option A) is not applicable to the Covered Call strategy. Credit risk (Option C) is more associated with certain fixed-income investments. Margin calls (Option D) are typically not a concern with Covered Call.
Relevant laws: Canadian securities regulations emphasize the importance of explaining the risk and reward profiles of different option strategies to investors.
Mr. Thompson owns 100 shares of XYZ stock and is concerned about potential downside. Which option strategy would provide him with protective insurance against a significant decline in the stock price?
Explanation:
The correct answer is C. Married Put. In a Married Put strategy, an investor buys a put option for each corresponding stock held, providing insurance against a substantial stock price decline. Covered Call (Option A) and Long Call (Option D) are bullish strategies. Short Put (Option B) is a strategy for investors expecting the stock to remain neutral or rise slightly.
Relevant laws: Canadian securities regulations stress the importance of explaining the risk and reward profiles of different option strategies to investors.
Explanation:
The correct answer is C. Married Put. In a Married Put strategy, an investor buys a put option for each corresponding stock held, providing insurance against a substantial stock price decline. Covered Call (Option A) and Long Call (Option D) are bullish strategies. Short Put (Option B) is a strategy for investors expecting the stock to remain neutral or rise slightly.
Relevant laws: Canadian securities regulations stress the importance of explaining the risk and reward profiles of different option strategies to investors.
What is a potential drawback of the Long Call strategy?
Explanation:
The correct answer is A. Unlimited loss potential. Long Call involves buying a call option to benefit from potential stock price appreciation. However, the investor’s loss is limited to the premium paid for the option. Limited profit potential (Option B) is more applicable to the Covered Call strategy. Margin calls (Option C) and credit risk (Option D) are generally not associated with the Long Call strategy.
Relevant laws: Canadian securities regulations require clear disclosure of the risk and reward profiles associated with different option strategies.
Explanation:
The correct answer is A. Unlimited loss potential. Long Call involves buying a call option to benefit from potential stock price appreciation. However, the investor’s loss is limited to the premium paid for the option. Limited profit potential (Option B) is more applicable to the Covered Call strategy. Margin calls (Option C) and credit risk (Option D) are generally not associated with the Long Call strategy.
Relevant laws: Canadian securities regulations require clear disclosure of the risk and reward profiles associated with different option strategies.
Ms. Brown owns 200 shares of ABC stock and wants to generate additional income. What strategy could she employ to achieve this goal?
Explanation:
The correct answer is C. Covered Call. In a Covered Call strategy, an investor sells call options against an existing stock position, generating income through the premiums received. Short Put (Option A) involves selling put options and is not an income-generating strategy. Married Put (Option B) is a protective strategy, and Long Call (Option D) is a bullish strategy.
Relevant laws: Canadian securities regulations emphasize the importance of explaining the risk and reward profiles of different option strategies to investors.
Explanation:
The correct answer is C. Covered Call. In a Covered Call strategy, an investor sells call options against an existing stock position, generating income through the premiums received. Short Put (Option A) involves selling put options and is not an income-generating strategy. Married Put (Option B) is a protective strategy, and Long Call (Option D) is a bullish strategy.
Relevant laws: Canadian securities regulations emphasize the importance of explaining the risk and reward profiles of different option strategies to investors.
Mr. Williams is an investor seeking income through option strategies. Which option strategy involves the investor writing (selling) put options?
Explanation:
The correct answer is C. Put Writing. Put Writing is a strategy where an investor sells put options to generate income. This strategy profits from stable or rising markets. Covered Call (Option A) involves selling call options, not puts. Iron Condor (Option B) and Long Straddle (Option D) are different strategies that don’t focus on writing put options.
Relevant laws: Canadian securities regulations emphasize the importance of understanding the risk and reward profiles of different option strategies.
Explanation:
The correct answer is C. Put Writing. Put Writing is a strategy where an investor sells put options to generate income. This strategy profits from stable or rising markets. Covered Call (Option A) involves selling call options, not puts. Iron Condor (Option B) and Long Straddle (Option D) are different strategies that don’t focus on writing put options.
Relevant laws: Canadian securities regulations emphasize the importance of understanding the risk and reward profiles of different option strategies.
Mrs. Anderson is concerned about potential market volatility. Which option strategy could help her benefit from a sideways market movement?
Explanation:
The correct answer is B. Iron Butterfly. The Iron Butterfly is a neutral strategy that profits from low volatility and a sideways market. Call Ratio Spread (Option A) and Long Straddle (Option D) are strategies that benefit from significant price movements, not stability. Put Writing (Option C) profits from stable or rising markets.
Relevant laws: Canadian securities regulations stress the importance of explaining the risk and reward profiles of different option strategies to investors.
Explanation:
The correct answer is B. Iron Butterfly. The Iron Butterfly is a neutral strategy that profits from low volatility and a sideways market. Call Ratio Spread (Option A) and Long Straddle (Option D) are strategies that benefit from significant price movements, not stability. Put Writing (Option C) profits from stable or rising markets.
Relevant laws: Canadian securities regulations stress the importance of explaining the risk and reward profiles of different option strategies to investors.
What benchmark index is commonly used to measure the performance of income-producing option strategies?
Explanation:
The correct answer is B. CBOE S&P 500 BuyWrite Index (BXM). This index measures the performance of a covered call strategy on the S&P 500 Index. S&P 500 (Option A), Dow Jones Industrial Average (Option C), and NASDAQ Composite (Option D) are not specific benchmarks for income-producing option strategies.
Relevant laws: Canadian securities regulations encourage investors to be aware of the benchmarks used to measure the performance of investment strategies.
Explanation:
The correct answer is B. CBOE S&P 500 BuyWrite Index (BXM). This index measures the performance of a covered call strategy on the S&P 500 Index. S&P 500 (Option A), Dow Jones Industrial Average (Option C), and NASDAQ Composite (Option D) are not specific benchmarks for income-producing option strategies.
Relevant laws: Canadian securities regulations encourage investors to be aware of the benchmarks used to measure the performance of investment strategies.
Which option strategy involves simultaneously buying and selling options of the same class and expiration date, but different strike prices?
Explanation:
The correct answer is B. Vertical Spread. A Vertical Spread, also known as a price spread, involves buying and selling options with different strike prices but the same expiration date. Long Straddle (Option A) involves buying both a call and a put with the same strike price and expiration date. Strangle (Option C) involves buying a call and a put with different strike prices but the same expiration date. Covered Call (Option D) is a different strategy.
Relevant laws: Canadian securities regulations stress the importance of understanding the risk and reward profiles of different option strategies.
Explanation:
The correct answer is B. Vertical Spread. A Vertical Spread, also known as a price spread, involves buying and selling options with different strike prices but the same expiration date. Long Straddle (Option A) involves buying both a call and a put with the same strike price and expiration date. Strangle (Option C) involves buying a call and a put with different strike prices but the same expiration date. Covered Call (Option D) is a different strategy.
Relevant laws: Canadian securities regulations stress the importance of understanding the risk and reward profiles of different option strategies.
Mr. Lee believes a stock will experience significant price volatility but is uncertain about the direction. Which option strategy would best suit his outlook?
Explanation:
The correct answer is B. Long Straddle. Long Straddle involves buying both a call and a put with the same strike price and expiration date, profiting from significant price movements. Covered Call (Option A) benefits from stable or slightly rising markets. Iron Condor (Option C) profits from low volatility and a sideways market. Put Writing (Option D) profits from stable or rising markets.
Explanation:
The correct answer is B. Long Straddle. Long Straddle involves buying both a call and a put with the same strike price and expiration date, profiting from significant price movements. Covered Call (Option A) benefits from stable or slightly rising markets. Iron Condor (Option C) profits from low volatility and a sideways market. Put Writing (Option D) profits from stable or rising markets.
Mrs. Smith is moderately bullish on a stock but wants to limit her upfront investment. Which option strategy could she employ?
Explanation:
The correct answer is A. Bull Call Spread. This strategy involves buying a call option with a lower strike and simultaneously selling a call option with a higher strike, reducing the net cost and limiting both potential gain and loss. Bull Put Spread (Option B) is a credit spread strategy. Long Call (Option C) involves buying a single call option, and Short Put (Option D) is a strategy for investors expecting the stock to remain neutral or rise slightly.
Relevant laws: Canadian securities regulations emphasize the importance of understanding risk and reward profiles in options trading.
Explanation:
The correct answer is A. Bull Call Spread. This strategy involves buying a call option with a lower strike and simultaneously selling a call option with a higher strike, reducing the net cost and limiting both potential gain and loss. Bull Put Spread (Option B) is a credit spread strategy. Long Call (Option C) involves buying a single call option, and Short Put (Option D) is a strategy for investors expecting the stock to remain neutral or rise slightly.
Relevant laws: Canadian securities regulations emphasize the importance of understanding risk and reward profiles in options trading.
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