FINRA Series 7 — All Questions

An investor buys a new 10-year zero-coupon municipal bond at its $600 original issue price (par $1,000). After four years, she sells it for $800. For this problem, assume the discount accretes straight-line. What is the tax result?

• a.A $40 gain that is tax-exempt, since it comes from a municipal security
• b.A $200 gain, with $160 of it taxed as interest income while she held the bond
• c.A $200 capital gain, because her basis stays at the original $600 purchase cost
• d.A $40 capital gain, because $160 of exempt accretion raised basis to $760✓

The $400 discount accretes at $40 a year, so after four years $160 has accreted. Original issue discount on a tax-exempt bond is treated as tax-exempt interest, and the accreted amount increases the basis to $760. Selling for $800 gives a $40 capital gain. Leaving the basis at $600 would tax interest that is exempt. The accretion is not taxable as income in the years held. Price appreciation beyond the accreted value is a capital gain even on a municipal bond.IRS Publication 550: tax-exempt original issue discount and basis on a sale

Banks often pay more for 'bank-qualified' municipal bonds than for other municipals. What makes a bond bank-qualified?

• a.A small issuer, up to $10 million a year; banks deduct 80% of carrying costs✓
• b.Bond insurance, which allows a bank to hold the issue with no capital set aside
• c.An investment-grade rating, the only grade that bank regulators allow banks to hold
• d.Issuance by a state bank authority, so that all of a bank's interest cost is deductible

A qualified tax-exempt obligation is issued by a small issuer that reasonably expects to issue no more than $10 million of tax-exempt obligations in the calendar year, and that has designated the bonds for this purpose. A bank holding them may deduct 80% of the interest cost of carrying them, which is why banks accept lower yields. A rating or insurance does not create the designation, and the issuer need not be connected to a bank. Other bonds leave the bank with no deduction for the interest allocable to them.IRC section 265(b)(3): bank-qualified tax-exempt obligations

An investor is in the 24% federal bracket and pays 6% state income tax. Assume her state taxes interest on other states' municipal bonds. She compares an in-state bond yielding 3.50% with an out-of-state bond of similar credit and maturity yielding 3.70%. Which has the higher after-tax yield?

• a.The in-state bond, at 3.50% against about 3.48% for the out-of-state bond✓
• b.The out-of-state bond, since 3.70% is higher and both are exempt from federal tax
• c.Neither, as both are exempt from federal tax and the yields are equal
• d.The in-state bond, since the other bond nets only 2.59% after both taxes

Both bonds are exempt from federal income tax. The in-state bond is also exempt from her state's tax, so it keeps its full 3.50%. The out-of-state bond is taxed by her state: 3.70% x (1 - 0.06) = 3.478%. The in-state bond is slightly higher. Comparing the stated yields ignores the state tax. Applying the federal rate to exempt interest, as in 3.70% x 0.70 = 2.59%, taxes something that is not taxed. The yields are not equal, because only one of them is exposed to state tax.Tax-exempt yield comparison: in-state versus out-of-state municipal bond

A single retiree has $18,000 of adjusted gross income that excludes Social Security, $9,000 of municipal bond interest, and $20,000 of Social Security benefits. Provisional income is AGI plus tax-exempt interest plus half of the benefits. The 85% tier begins above $34,000. What is the result?

• a.Provisional income is $37,000, yet no benefits are taxable because interest is exempt
• b.Provisional income is $37,000, so up to 85% of the benefits may be taxable✓
• c.Provisional income is $47,000, since all of the benefits are included
• d.Provisional income is $28,000, so up to 50% of the benefits could be taxable

Provisional income is $18,000 + $9,000 + half of $20,000, or $10,000, which equals $37,000. Tax-exempt interest counts in this formula even though it is not taxed itself. That is above the $34,000 threshold for a single filer, so up to 85% of the benefits may be taxable. Leaving the municipal interest out gives $28,000 and the 50% tier. Adding all of the benefits instead of half gives $47,000. Counting the interest does not make the benefits tax-free; it increases the amount subject to tax.IRS Publication 915: tax-exempt interest and provisional income

An investor buys a new-issue municipal bond at par ($1,000). Eight months later, after interest rates fall, she sells it for $1,040. What is the federal tax treatment of the $40?

• a.Tax-exempt as part of the bond, since it is a municipal security
• b.A short-term capital gain, while the coupons stay tax-exempt✓
• c.A long-term capital gain, since municipal bonds are long-term
• d.Ordinary interest income, because the gain is part of the bond's yield

Municipal bond interest is excluded from federal income, but a gain on selling the bond is a capital gain like any other. Held for less than a year, it is a short-term gain taxed at ordinary rates. The type of bond does not exempt the gain from tax. The holding period is measured by how long the investor owned it, not by the bond's term. The gain came from a change in market price, not from market discount or accretion, so it is not interest income.Capital gains on municipal bonds: price appreciation is taxable

A county treasurer plans to place idle cash in a pooled fund run by the state that many local governments use. How are interests in such a local government investment pool (LGIP) classified?

• a.Bank deposits that are insured up to the FDIC limit for each government
• b.Short-term notes of the state, backed by its full faith and credit
• c.Municipal fund securities, so dealers that sell them are subject to MSRB rules✓
• d.Shares of a money market fund registered under the Investment Company Act

MSRB Rule D-12 defines municipal fund securities as municipal securities that would be investment company securities if they had not been issued by a governmental entity. Examples are 529 plans, ABLE programs and local government investment pools, and dealers selling them follow MSRB rules. An LGIP is not registered under the 1940 Act. It is not a note backed by the state's credit, because investors share in the pool's investments and its value can change. It is not a bank deposit, so FDIC insurance does not apply to it.MSRB Rule D-12: local government investment pools as municipal fund securities

In 2026, Maria is 49 and has a severe disability that began when she was 33. She meets the other ABLE eligibility requirements. Can she open an ABLE account?

• a.Yes, since the onset age limit rose to 46 on January 1, 2026✓
• b.No, because the owner must be under age 46 on the day of opening
• c.No, because the disability must have begun before she turned 26
• d.Yes, since ABLE accounts set no limit on when the disability began

ABLE eligibility turns on the age at which the disability began, not the owner's current age. The ABLE Age Adjustment Act raised that limit from 26 to 46 effective January 1, 2026, so onset at 33 qualifies even though Maria is 49 now. Before 2026 the onset limit of 26 would have excluded her. There is still an onset limit. The age cap does not apply to her current age.Achieving a Better Life Experience (ABLE) Act, as amended by the ABLE Age Adjustment Act

A grandmother contributes $80,000 to a 529 plan for her grandson in one year and elects to treat the gift as made over five years. She makes no other gifts to him, and the annual gift tax exclusion is $19,000. What is the result?

• a.$16,000 counts in each of the five years, all within the exclusion, so nothing is taxable✓
• b.$80,000 counts in the first year, and $61,000 of it exceeds the annual exclusion
• c.The election is unavailable below $95,000, so $61,000 of the gift is taxable
• d.$16,000 counts in each year, but no gift tax return is needed because every year stays under the exclusion

Electing the five-year spread treats the gift as made in equal parts, so $80,000 counts as $16,000 a year, which is below the $19,000 exclusion every year. Since $80,000 is under five times the exclusion ($95,000), nothing is left over and no part is a taxable gift. Counting the whole $80,000 in year one is the result without the election. The $95,000 figure is a ceiling on what may be spread, not a minimum needed to make the election. A gift tax return must still be filed to make the election, even though no tax is due.IRC section 529(c)(2)(B): five-year gift election for 529 contributions

A customer buys 1 CBRG Jan 55 call at 6.40 and sells 1 CBRG Jan 65 call at 2.15. At expiration CBRG closes at 68. Ignoring commissions, what is the customer's net result?

• a.A gain of $425
• b.A gain of $1,425
• c.A gain of $1,000
• d.A gain of $575✓

The spread costs a net debit of 4.25 (6.40 minus 2.15), or $425. With CBRG at 68 both calls are in the money and the spread is worth its full 10-point width, $1,000. The $1,000 less the $425 debit leaves a gain of $575. A $1,000 gain forgets the premium paid. A $425 gain treats the debit as the profit. A $1,425 gain adds the debit to the width instead of subtracting it.

A customer buys 1 HLXN Mar 80 put at 7.90 and sells 1 HLXN Mar 70 put at 3.40. At expiration HLXN closes at 62. Ignoring commissions, what is the customer's net result?

• a.A gain of $450
• b.A gain of $550✓
• c.A gain of $1,000
• d.A gain of $1,550

The net debit is 4.50 (7.90 minus 3.40). With HLXN at 62 the long 80 put is worth 18 and the short 70 put costs 8, so the spread is worth its full 10-point width, $1,000. Subtracting the $450 debit leaves $550. A $1,000 gain ignores the premium paid. A $450 gain mistakes the debit for the profit. A $1,550 gain adds the debit to the width.

A customer sells 1 VRTA Feb 45 put at 3.60 and buys 1 VRTA Feb 40 put at 1.25. VRTA closes at 36 at expiration. Ignoring commissions, what is the customer's net result?

• a.A loss of $235
• b.A loss of $540
• c.A loss of $265✓
• d.A loss of $500

The net credit is 2.35 (3.60 minus 1.25), or $235. At 36 the short 45 put costs 9 and the long 40 put recovers 4, so the spread loses 5, or $500. The $235 credit offsets part of that, leaving a $265 loss, which is also the maximum loss on this credit put spread (width less credit). A $500 loss ignores the credit received. A $235 loss treats the credit as the loss. A $540 loss ignores the protection of the long put and counts only the short put against the 3.60 premium.

A customer buys 1 QNTM Jun 120 call and sells 1 QNTM Jun 130 call, paying a net debit of 3.10. Which statement describes this position?

• a.A bull call spread that profits if QNTM rises, with no limit on the potential gain
• b.A bull call spread that profits if QNTM rises, with a maximum loss of $310✓
• c.A bull call spread that profits if QNTM rises, with a maximum loss of $690
• d.A bear call spread that profits if QNTM falls, with a maximum loss of $690

Buying the lower-strike call and selling the higher-strike call in the same month is a debit (bull) call spread. The most the customer can lose is the net debit, 3.10 x 100 = $310. The most the customer can make is the 10-point width less the debit, $690, so $690 is the maximum gain and not the maximum loss. Selling the 130 call caps the upside, so the gain is not unlimited. A bear call spread would sell the lower strike and buy the higher strike, and it would bring in a credit.

A customer sells 1 OPAL Apr 50 call at 4.80 and buys 1 OPAL Apr 55 call at 2.20. At expiration OPAL closes at 53.50. Ignoring commissions, what is the customer's net result?

• a.A loss of $240
• b.A loss of $90✓
• c.A gain of $260
• d.A loss of $350

The net credit is 2.60 (4.80 minus 2.20), or $260. At 53.50 the short 50 call costs 3.50 while the long 55 call expires worthless, so the credit less the $350 cost leaves a $90 loss. The breakeven on this credit call spread is 52.60. A $240 loss is the maximum loss, but it occurs only at 55 or higher. A $350 loss ignores the credit. A $260 gain would require OPAL to close at or below 50.

A customer buys 1 BRNX Sep 35 call at 5.10 and sells 1 BRNX Sep 45 call at 1.60. At what BRNX price at expiration does the customer break even?

• a.31.50
• b.38.50✓
• c.36.60
• d.48.50

The net debit is 3.50 (5.10 minus 1.60). A debit call spread breaks even at the lower strike plus the net debit: 35 + 3.50 = 38.50. Adding only the short call's premium to the lower strike gives 36.60. Adding the debit to the higher strike gives 48.50, which is above the price where the spread already reaches its maximum value. Subtracting the debit from the lower strike gives 31.50, the formula for a long put.

A customer holds a bull call spread on ZPHR: long 1 Dec 40 call and short 1 Dec 50 call. With ZPHR at 57 and three weeks to expiration, the short 50 call is assigned. Which statement is correct?

• a.The customer can decline to deliver because the assignment came before expiration
• b.The assignment is cancelled because the position was a spread when it was assigned
• c.The long 40 call is automatically exercised to offset the assigned short call
• d.The customer can exercise the long 40 call to obtain the shares needed for delivery✓

American-style equity options can be assigned at any time before expiration. The assigned writer must deliver 100 shares at 50, and the customer can obtain those shares by exercising the long 40 call. Nothing exercises the long call automatically, and spreads are not netted or cancelled by the clearing corporation, so the assigned writer cannot decline to deliver. Exercising early surrenders the long call's remaining time value, which is why the customer may prefer to buy the shares in the market and keep the call.FINRA Rule 2360

A customer buys 1 FRNT Aug 60 put at 5.30 and sells 1 FRNT Aug 50 put at 2.10. At expiration FRNT closes at 56. Ignoring commissions, what is the customer's net result?

• a.A gain of $400
• b.A gain of $680
• c.A gain of $80✓
• d.A loss of $320

The net debit is 3.20 (5.30 minus 2.10), or $320. At 56 the long 60 put is worth 4 and the short 50 put expires worthless, so the position returns $400 against a $320 cost, a gain of $80. A $320 loss assumes the long put expired worthless, but 56 is below the 60 strike. A $400 gain ignores the premium paid. A $680 gain is the maximum gain, which requires FRNT at 50 or lower.

A customer sells 1 TRVL Jul 55 call at 2.40 and sells 1 TRVL Jul 45 put at 1.90. Ignoring commissions, what are the two breakeven prices at expiration?

• a.42.60 and 56.90
• b.45.70 and 54.30
• c.40.70 and 59.30✓
• d.43.10 and 57.40

The total credit is 4.30 (2.40 plus 1.90). The writer of a strangle is protected by the whole credit on each side: the lower breakeven is the put strike less 4.30 (40.70) and the upper is the call strike plus 4.30 (59.30). Moving 4.30 from the midpoint of 50 gives 45.70 and 54.30, which ignores the gap between the strikes. Using each leg's own premium gives 43.10 and 57.40. Swapping the two premiums gives 42.60 and 56.90.

A customer sells 1 MRDN Oct 70 call at 3.20 and sells 1 MRDN Oct 60 put at 2.50. At expiration MRDN closes at 52. Ignoring commissions, what is the customer's net result?

• a.A loss of $800
• b.A loss of $1,370
• c.A gain of $570
• d.A loss of $230✓

The total credit is 5.70 (3.20 plus 2.50), or $570. At 52 the call expires worthless and the short 60 put costs 8, or $800. The $570 credit less the $800 cost leaves a $230 loss; the lower breakeven is 54.30, so 52 is below it. A $800 loss ignores the credit. A $570 gain would require MRDN to close between 60 and 70. A $1,370 loss adds the credit to the cost instead of subtracting it.

A customer buys 1 ORBT Nov 80 call at 4.50 and buys 1 ORBT Nov 80 put at 3.70. At expiration ORBT closes at 90. Ignoring commissions, what is the customer's net result?

• a.A loss of $820
• b.A gain of $1,820
• c.A gain of $1,000
• d.A gain of $180✓

The long straddle costs 8.20 (4.50 plus 3.70), or $820. At 90 the call is worth 10 and the put expires worthless, so the position returns $1,000 against an $820 cost, a gain of $180. The upper breakeven is 88.20. A $1,000 gain ignores the premium paid. A $820 loss is the maximum loss, which occurs only if ORBT closes exactly at 80. A $1,820 gain adds the cost to the intrinsic value.

A customer buys 1 PLVR Dec 90 call at 2.20 and buys 1 PLVR Dec 80 put at 1.60. What is the customer's maximum loss, and when does it occur?

• a.$380, if PLVR closes exactly at 85 at expiration
• b.$220, if PLVR closes between 80 and 90 at expiration
• c.$380, if PLVR closes at 76.20 or 93.80 at expiration
• d.$380, if PLVR closes between 80 and 90 at expiration✓

Buying a call and a put on the same stock with different strikes is a long combination, so it costs 3.80 (2.20 plus 1.60), or $380. That is the most the customer can lose, and the full loss occurs whenever both options expire worthless: any close from the put strike of 80 to the call strike of 90. The loss does not require a close at the midpoint. The $220 figure counts only the call's premium. The prices 76.20 and 93.80 are the breakevens, where the loss has fallen to zero.

A customer sells 1 GLDN May 50 call at 3.00 and sells 1 GLDN May 50 put at 2.50. GLDN then jumps to 61, and the customer buys both options back for a combined 12.50. Ignoring commissions, what is the customer's net result?

• a.A gain of $700
• b.A loss of $1,250
• c.A loss of $1,800
• d.A loss of $700✓

The short straddle brought in 5.50 (3.00 plus 2.50), or $550. Buying it back for 12.50 costs $1,250, so the closing transaction produces a loss of $700. A $1,250 loss ignores the premium originally received. A $1,800 loss adds the credit to the buyback cost. A $700 gain reverses the sign, as if the position had been bought at 12.50 and sold at 5.50 rather than the other way around.

A customer sells 1 SNRX Jun 60 call at 1.10 and buys 1 SNRX Sep 60 call at 3.30 with SNRX trading at 60. What is the customer most likely expecting?

• a.SNRX will fall well below 60 before June, since the short call expires sooner
• b.SNRX will rise well above 60 before June, since the long call expires later
• c.SNRX will move sharply either way before June, since both strikes are the same
• d.SNRX will stay near 60 through June, while the June call loses time value faster✓

Selling the near-month call and buying the later-month call at the same strike is a calendar (time) spread. The near-term option has the faster time-value decay, so the position is at its best when the stock is at the strike as the short call expires. A sharp rise or fall would make the short June call an in-the-money liability and shrink the gain, and a sharp move in either direction is what a long straddle needs, not a calendar spread.

A customer buys 1 ZENT May 50 call at 6.00 and sells 2 ZENT May 55 calls at 3.00 each, for no net debit or credit. Above what ZENT price at expiration does the position begin to lose money?

• a.Above 65
• b.Above 50
• c.Above 60✓
• d.Above 55

This is a call ratio spread: one long call and two short calls. The position reaches its maximum gain of 5 points ($500) at 55. Above 55 the extra short call loses one point for each point of stock price, so the 5-point cushion is used up at 60, and losses are unlimited beyond that. Above 55 is the point of maximum gain, not the breakeven. Above 50 is where the long call first goes in the money, and above 65 does not follow from any strike or premium in the position.

A customer buys 1 CRSN Dec 70 call and sells 1 CRSN Sep 75 call. This position is best described as a:

• a.diagonal spread, because the strikes and the expiration months both differ✓
• b.calendar spread, because the strikes are equal but the expiration months differ
• c.combination, because the strikes and the expiration months both differ
• d.vertical spread, because the strikes differ but the expiration months are equal

A spread pairs two options of the same type on the same stock. When only the strike differs it is a vertical (price) spread, when only the expiration differs it is a calendar (horizontal or time) spread, and when both differ it is a diagonal spread. A combination pairs a call with a put, so two calls cannot form one, whatever their strikes and months.FINRA Rule 2360

A customer buys 100 shares of LUMN at 40 and sells 2 LUMN 45 calls at 2.00 each. Ignoring commissions, at what LUMN price does the position break even on the upside?

• a.45
• b.47
• c.54✓
• d.49

Only one of the two calls is covered. The position gains 5 points on the stock plus the 4 points of premium received, a maximum gain of 9 at a stock price of 45. Above 45 the shares gain one point per point, but the two short calls lose two, so the position gives back one point per point and the 9-point gain is gone at 54. The prices 49 and 47 add part of the premium to the strike without allowing for the second short call, and 45 is where the maximum gain, not the breakeven, occurs.

A customer sells short 100 shares of SKLD at 62 and sells 1 SKLD Mar 60 put at 3.50. Ignoring commissions, what is the customer's maximum potential gain?

• a.$550✓
• b.$350
• c.$6,550
• d.$200

Selling a put against short stock is a covered put. If SKLD falls below 60 the put is assigned and the customer buys 100 shares at 60 to close the short, keeping the 2-point gain from selling at 62 plus the 3.50 premium: 5.50 x 100 = $550. That is the cap, because further declines below 60 benefit the put holder. $350 counts only the premium and $200 counts only the stock gain. $6,550 treats the position as an ordinary short sale that profits all the way to zero.

A customer sells short 100 shares of DNVR at 48 and sells 1 DNVR 45 put at 2.20. Ignoring commissions, what is the breakeven price?

• a.45.80
• b.47.20
• c.42.80
• d.50.20✓

The short stock loses money as DNVR rises, and the 2.20 premium cushions that loss, so the breakeven is the short-sale price plus the premium: 48 + 2.20 = 50.20. Subtracting the premium from 48 (45.80) is the covered call formula. Subtracting it from the strike (42.80) is the short put formula, and adding it to the strike (47.20) matches neither position. The covered put has unlimited risk above its breakeven.

A customer sells short 100 shares of KTRL at 35 and buys 1 KTRL 40 call at 1.40. Ignoring commissions, what is the customer's maximum loss?

• a.$360
• b.$140
• c.$500
• d.$640✓

A short sale protected by a long call is a protected short. Above 40 the call offsets every further rise, so the loss stops at the 5-point difference between the short-sale price and the strike, plus the 1.40 premium paid: 6.40 x 100 = $640. $140 counts only the premium and $500 counts only the stock loss. $360 subtracts the premium instead of adding it.

A customer owns 100 shares of NRTH bought at 50. The customer buys 1 NRTH 45 put at 1.80 and sells 1 NRTH 55 call at 2.30. Ignoring commissions, what is the customer's maximum loss on the combined position?

• a.$500
• b.$550
• c.$680
• d.$450✓

This is a collar. The put limits the loss on the shares to the 5 points between the purchase price and the 45 strike, and the net credit of 0.50 (2.30 minus 1.80) reduces it: 4.50 x 100 = $450. A $500 loss ignores the net credit. $550 is the maximum gain, the 5 points to the 55 strike plus the 0.50 credit. $680 adds the put premium to the stock loss and ignores the premium received for the call.

A customer owns 300 shares of ALTO bought at 52 and buys 2 ALTO 50 puts at 1.60 each. ALTO falls to 40 at expiration and the puts are exercised. Ignoring commissions, what is the customer's total loss on the stock and options combined?

• a.$920
• b.$1,920✓
• c.$3,600
• d.$1,600

The shares lose 12 points each, $3,600. The two puts cover only 200 shares and deliver them at 50, which recovers 10 points on 200 shares, $2,000; the puts cost 1.60 x 200 = $320. The total loss is $3,600 less $2,000 plus $320, or $1,920. A $3,600 loss ignores the puts. A $1,600 loss leaves out the premium paid. A $920 loss assumes the puts protect all 300 shares.

A customer sells short 200 shares of VELA at 44 and buys 2 VELA 46 calls at 1.50 each. VELA falls to 36 and the calls expire worthless. Ignoring commissions, what is the customer's net gain?

• a.$1,900
• b.$1,700
• c.$1,300✓
• d.$1,600

The short sale gains 8 points on 200 shares, $1,600. The two calls expired worthless and cost 1.50 x 200 = $300, so the net gain is $1,300. A $1,600 gain ignores the cost of the protection. A $1,900 gain adds the premium instead of subtracting it. A $1,700 gain measures the gain from the call strike of 46 rather than from the short-sale price of 44.

A customer buys 2 HWX Dec 1250 calls at 14 on the Hartwell 400 Index, a broad-based, cash-settled index. At expiration the index closes at 1291. Ignoring commissions, what is the customer's net result?

• a.A gain of $8,200
• b.A net gain of $6,800
• c.A gain of $2,700
• d.A net gain of $5,400✓

Each call is worth 41 points at expiration (1291 minus 1250), or $4,100 per contract. Subtracting the 14-point premium ($1,400) leaves $2,700 per contract, and two contracts produce $5,400. Because the option is cash-settled, the gain is paid in cash and no shares change hands. A $2,700 gain counts only one contract. A $8,200 gain ignores the premium. A $6,800 gain deducts the premium for only one of the two contracts.

A portfolio manager holds a diversified stock portfolio worth $960,000 that closely tracks a broad-based index now at 3,200. The manager wants to hedge with index puts that carry a multiplier of 100. How many put contracts provide a full hedge?

• a.30 contracts, because each one covers $32,000 of index value
• b.300 contracts, because each covers $3,200 of index value
• c.32 contracts, because each one covers $30,000 of index value
• d.3 contracts, because each covers $320,000 of index value✓

An index option covers the index level times the multiplier: 3,200 x 100 = $320,000 per contract. Dividing the $960,000 portfolio by $320,000 gives 3 puts. Using 30 contracts treats the multiplier as 10. Using 300 contracts leaves out the multiplier and divides by the index level alone. Using 32 contracts divides the index level by the multiplier, which is not a measure of dollar value at all.

With the 10-year Treasury yield at 4.35%, a customer buys 2 yield-based Dec 44 calls at 1.20. The measure is ten times the yield (4.35% is 43.5) and the multiplier is 100. At expiration the yield is 4.80%. Ignoring commissions, what is the customer's net result?

• a.A gain of $800
• b.A gain of $1,040
• c.A gain of $280
• d.A gain of $560✓

A yield of 4.80% gives a measure of 48.0. The call is worth 4.0 points (48.0 minus the 44 strike), or $400 per contract. Subtracting the 1.20 premium ($120) leaves $280 per contract, and two contracts produce $560, paid in cash. A $800 gain ignores the premium. A $280 gain counts one contract. A $1,040 gain adds the premium to the intrinsic value instead of subtracting it.

A pension manager holds long-term Treasury bonds and fears that yields will rise. Which yield-based option position hedges that risk?

• a.Buy yield-based calls, because they gain if yields rise✓
• b.Buy yield-based puts, because they gain value if bond prices fall
• c.Sell yield-based puts, because they lose value if yields rise
• d.Sell yield-based calls, because the premium offsets bond losses

Rising yields mean falling bond prices, so the manager needs a position that gains when the yield measure goes up. A long yield-based call does exactly that. A yield-based put gains when yields fall, so buying one treats yield and price as moving together, which is the common confusion. A short call loses more as yields rise, which adds to the exposure. A short put keeps only its premium if yields rise, so the protection is capped at a small amount and the position loses if yields fall.

A U.S. exporter will receive 500,000 euros in three months and worries that the euro will weaken against the dollar. Which listed foreign-currency option position hedges the exposure?

• a.Sell euro puts, which earn the premium if the euro stays above the strike
• b.Buy euro puts, which gain value if the euro weakens against the dollar✓
• c.Sell euro calls, which earn the premium if the euro stays below the strike
• d.Buy euro calls, which gain value if the euro strengthens against the dollar

The exporter loses if the euros received are worth fewer dollars, so the hedge must gain when the euro falls. A long euro put sets a minimum dollar value for the euros. A long euro call is the importer's hedge and gains when the euro rises, which the exporter does not need. A short call brings in only a small premium and gives no protection against a large drop. A short put loses more as the euro falls, which doubles the exposure.

Which statement about long-term equity anticipation securities (LEAPS) is correct?

• a.They are listed with expirations at least 12 months after the listing date✓
• b.They are available only to institutional customers, not to retail investors
• c.They are issued with a strike price that is never adjusted for stock splits
• d.They are listed only on broad-based indexes and never on individual stocks

LEAPS are long-term options, listed with expirations at least a year after the date they are listed, so a newly listed series always has a year or more to run. They are not restricted to institutions: any customer approved for options trading can buy them. They are available on individual stocks and exchange-traded funds as well as on indexes, and they are adjusted for splits and other corporate actions in the same way as any other series.Cboe Rule 4.5(f)(1) and 4.13(b)(1): long-term options (LEAPS)

A customer owns a European-style index call that is deep in the money with three weeks to expiration and wants to realize the gain now. Which statement is correct?

• a.The customer can exercise the call only during the final trading week before the expiration date
• b.The customer must hold the call to expiration because European-style options cannot be sold
• c.The customer can sell the call in the market, but exercise is possible only on the expiration date✓
• d.The customer can exercise now and receive the cash settlement amount the next business day

A European-style option can be exercised only on its expiration date, but it trades freely before then, so the customer can capture the gain by selling it. Exercising early is not allowed. The last-week window is not a feature of European-style options, which have a single exercise date. The restriction on exercise has no effect on whether the option can be sold.

At the open, a customer is long 8 contracts of an American-style index call series. During the morning the customer buys 3 more contracts in opening purchases and sells 2 contracts in closing sales. What is the largest number of contracts the customer may be instructed to exercise that day?

• a.9 contracts✓
• b.8 contracts
• c.6 contracts
• d.11 contracts

The net long position is the opening position (8), plus opening purchases made that day (3), less closing sales made that day (2): 8 + 3 - 2 = 9. Eleven contracts ignores the closing sales. Eight contracts uses only the opening position and leaves out the new purchases. Six contracts subtracts the sales but also drops the purchases.Cboe Rule 6.20(e)

A firm allocates exercise notices on a first-in, first-out basis. Customer A sold 3 XYZ Jan 60 calls on October 1, customer B sold 5 on October 14, and customer C sold 2 on October 20. The firm is assigned an exercise notice for 5 contracts. Which allocation results?

• a.Customer A is assigned 3 contracts, then customer B is assigned the other 2 contracts✓
• b.Customer C is assigned 2 contracts, then customer B is assigned the other 3
• c.Customers A, B and C are each assigned in proportion to their positions
• d.Customer B is assigned all 5 contracts because it has the largest position

First in, first out assigns exercise notices to the oldest short positions first. Customer A's 3 contracts from October 1 are assigned, then 2 of customer B's 5 contracts from October 14. Position size does not matter under this method. Proportional assignment is not one of the permitted methods, which are first-in-first-out or random selection. Starting with the newest position is the reverse of first-in-first-out. The firm must also tell customers in writing which method it uses.Cboe Rule 6.21

Before the exercise cutoff on Friday, October 16, 2026, a customer instructs the firm to exercise a long XYZ call on 100 shares. On what date does the stock settle?

• a.Monday, October 19, 2026✓
• b.Wednesday, October 21, 2026
• c.Friday, October 16, 2026
• d.Tuesday, October 20, 2026

Equity option exercises settle on the first business day after the exercise, in line with the one-business-day standard cycle that took effect on May 28, 2024. An exercise on Friday therefore settles on Monday. Tuesday would be the old two-business-day cycle. Friday would require same-day settlement, which is not the standard. Wednesday adds a third business day that no current cycle uses.OCC Rules; SEC Rule 15c6-1(a)

A customer is short 4 XYZ calls when XYZ completes a 3-for-2 stock split. OCC adjusts the options by keeping the number of contracts the same and increasing the number of shares each contract delivers. If all 4 calls are later assigned, how many shares must the customer deliver?

• a.400 shares
• b.600 shares✓
• c.900 shares
• d.800 shares

A 3-for-2 split gives holders 1.5 shares for each share held, so each adjusted contract covers 150 shares instead of 100. Four contracts therefore require 4 x 150 = 600 shares. Four hundred shares ignores the adjustment. Eight hundred shares treats the split as a 2-for-1 that doubles the contracts. Nine hundred shares applies the 1.5 factor twice, once to the contract count and once to the shares.OCC By-Laws Art. VI, Sec. 11A

XYZ trades at 54.50 and an XYZ 60 put is quoted at 7.10. What are the put's intrinsic value and time value?

• a.Intrinsic value 1.60; time value 5.50
• b.Intrinsic value 5.50; time value 1.60✓
• c.Intrinsic value 7.10; time value 0
• d.Intrinsic value 0; time value 7.10

A put is in the money by the amount the strike exceeds the stock price: 60 minus 54.50 = 5.50. Time value is the premium less intrinsic value: 7.10 minus 5.50 = 1.60. Intrinsic value of 0 would describe an out-of-the-money put, which this is not. Swapping the two figures reverses the roles of intrinsic and time value. Treating the whole premium as intrinsic value ignores that the put still has time to expiration.

A customer owns 1 XYZ Nov 50 call and 1 XYZ Nov 50 put with XYZ at 50. Overnight, with XYZ unchanged and no meaningful passage of time, implied volatility falls from 40% to 28%. What is the most likely effect on the customer's position?

• a.The combined position gains value because lower volatility favors holders
• b.The combined position is unchanged because the stock price has not moved
• c.The call gains what the put loses, so the net change is close to zero
• d.Both options lose value, so the combined position is worth less✓

Both the call and the put gain value when implied volatility rises and lose value when it falls, because a quieter market makes a large move in either direction less likely. A long straddle therefore falls in value even if the stock price does not change. Price is not the only input to an option premium. Calls and puts move together on volatility rather than offsetting each other. Lower volatility is a disadvantage to the holder.

Before today's session an XYZ Dec 70 call had open interest of 120 contracts. Today investor A buys 15 contracts to open from investor B, who sells 15 to open. Investor C sells 5 contracts to close to investor D, who buys 5 to close. What are today's volume and the end-of-day open interest?

• a.Volume 40; open interest 130
• b.Volume 20; open interest 140
• c.Volume 20; open interest 120
• d.Volume 20; open interest 130✓

Volume counts each contract traded once, whatever the number of parties: 15 + 5 = 20. Open interest rises by 15 for the new positions opened on both sides and falls by 5 when both sides close, so 120 + 15 - 5 = 130. Volume of 40 counts the buyer and seller of each trade separately. Open interest of 140 treats the closing trade as another opening. Open interest of 120 treats the day as having no net effect.

The position limit for XYZ options is 25,000 contracts. A customer is long 17,000 XYZ calls, short 6,000 XYZ puts and long 9,000 XYZ puts. How many more XYZ calls may the customer buy in opening transactions?

• a.8,000 more calls, because only the long calls count against the limit
• b.2,000 more calls, because long calls and short puts are counted together✓
• c.11,000 more calls, because the long puts offset part of the position
• d.None, because all three positions count together and exceed 25,000

Long calls and short puts are on the same side of the market and are added together: 17,000 + 6,000 = 23,000, which leaves room for 2,000 more. The 9,000 long puts are on the opposite side and are not combined with them. Counting only the long calls leaves out the short puts. Netting the long puts against the bullish side is not allowed, because opposite sides are tracked separately. Adding all three positions mixes the two sides and overstates the position.Cboe Rule 8.30

The exercise limit for XYZ options is 25,000 contracts. A customer exercised 15,000 XYZ calls on Monday and 8,000 XYZ calls on Wednesday of the same week. Without special permission, how many more XYZ calls may the customer exercise on Friday of that week?

• a.10,000 calls
• b.2,000 calls✓
• c.17,000 calls
• d.25,000 calls

The exercise limit applies to the total exercised within any five consecutive business days. Monday through Friday is five business days, so the 15,000 and the 8,000 are added together: 25,000 minus 23,000 leaves room for 2,000. Ten thousand counts only Monday's exercise. Seventeen thousand counts only Wednesday's. Twenty-five thousand treats each day as a fresh start.Cboe Rule 8.42(a)

A customer who is not an options dealer sells 3 XYZ Mar 50 calls at 2.40, receiving $720, and the calls expire unexercised. How is the $720 taxed?

• a.As no gain, because the premium reduces the basis of the stock
• b.As ordinary income taxed in the year the premium was received
• c.As a long-term capital gain if XYZ stock was held for over a year
• d.As a short-term capital gain that is recognized when the calls expire✓

The premium on an option that is written and then lapses is a short-term capital gain, whatever the writer's holding period in any related stock, and it is recognized when the obligation ends, not when the premium is received. It is not ordinary income. The premium reduces stock basis only when a written put is exercised and the writer buys the stock. A lapsed call has no stock transaction at all.IRS Pub. 550, Puts and Calls

A customer buys 3 XYZ LEAPS calls at 5.00 on October 15, 2024. The calls expire worthless on December 19, 2025. How is the $1,500 loss treated?

• a.As an ordinary loss that is fully deductible against wage income
• b.As a nondeductible loss, because an expiration does not count as a sale
• c.As a short-term capital loss, because options are always short-term
• d.As a long-term capital loss, because the holding period ran past one year✓

The cost of an option that expires is a capital loss, treated as long-term or short-term depending on the holding period, which ends on the expiration date. Here the calls were held about 14 months, so the loss is long-term. There is no rule that options are always short-term. The loss is capital and so is limited against ordinary income. An expired option is treated as sold or exchanged on the expiration date, so the loss is recognized.IRS Pub. 550, Puts and Calls

A customer buys 1 XYZ Jun 50 call at 4.50, holds it for nine months, exercises it and buys 100 shares at 50. Four months after the exercise the customer sells the shares at 62. Ignoring commissions, how is the result taxed?

• a.A $750 long-term capital gain
• b.A $1,200 long-term capital gain
• c.A $750 short-term capital gain✓
• d.A $1,200 short-term capital gain

The call's cost is added to the basis of the stock, so the basis is 54.50 and the gain is 62 minus 54.50 = 7.50, or $750. The holding period for stock acquired by exercising an option starts the day after exercise, and the nine months the call was held do not count, so four months makes the gain short-term. A $1,200 gain leaves the premium out of the basis. Adding the option's holding period to the stock's is the mistake behind the long-term answers.IRS Pub. 550, Puts and Calls