Quiz Answers

Thanks to everyone who participated in Friday's quiz.  I learned some lessons by offering this quiz.

The first is that these polls do not appear on an RSS feed.  For that I apologize.  If anyone has a solution to that problem, I'd appreciate hearing about it.


The answers

1) Which of these is the main difference between writing 5 AAPL Dec 280 covered calls and selling 5 AAPL Dec 280 puts?

c) Commissions are higher for the covered call

It's true that the trades are equivalent and it makes no difference which you own.  However, transaction costs are not considered when positions are compared.  Writing covered calls requires payment of two commissions, vs. one for the put sale.  For traders who have tiny commissions, this difference is unimportant.

The trap on this question is the fallacy that selling naked puts is far more dangerous.  Writing covered calls is no different from writing a naked put.  The profit/loss profiles are identical – when the strike price and expiration date of the put and call are also identical.

The fact that so many (17%) chose the 'dangerous' put as their answer suggests that  some basic topics for option rookies are worth revisiting.  This specific misconception should be addressed early in a trader's career.  Look for more on this topic tomorrow


2) You feel XYZ (no dividends) is headed lower. Which trade is better:

i) Sell Jan 90/95C spread; collect $2 premium

ii) Buy Jan 90/95P spread; pay $3 premium

d)* they are equivalent and it makes no difference

However, in all fairness I want to point out that it is better to collect $300 cash than to pay $200 for the equivalent position.  With interest rates so low, today the answer is that it makes no difference.  But be aware that when interest rates are higher, it's better to collect interest on $300 than to pay it on $200.

*Thus, if you chose 'Sell the call spread' for the reason stated above, consider that to be the correct answer.

The price of XYZ makes no difference.  The two spreads have identical financial outcomes when expiration arrives.  Each can earn a maximum profit of $200 and incur a maximum loss of $300.

For anyone who wants to look more deeply into a detail of the trade, it is better to sell the call spead for this reason:  If you are correct and the stock does decline, the calls expire worthless and the puts expire in the money.  Most brokers get away with charging a fee (and a relatively steep one) for each exercise or assignment.  Thus, selling the call spread avoids paying those two fees – when you are correct in your prognostication.


3) Rank them in order: most profitable to largest loss


Once I amended the question requesting that you enter the correct sequence as 'other' 2/3 of responders had the correct answer.

b) is the most profitable because time passes and nothing happens

a) is next.  It's basically the same situation as b).  The difference is that implied volatility has increased – and that results is less profit for the iron condor trader

c) The 40-point decline is not good, but it is not as bad as

d) the 100 -point rally.  The short call option is now 30 points in the money


4) Which of the following offers the best alternative for the majority of individual investors?

The two options related answers garnered 80% of the votes.  And those are the two best answers to the question.

c) Sell the entire portfolio and replace each 100 shares of stock with an in the money (delta 70) call option

More than twice as many voters chose d), rather than c).  An explanation is in order.

Buying the puts is straightforward.  The trader maintains possession of his/her portfolio and protects the downside by owning a put option.  However, owing 100 shares of stock and one put option is equivalent to owning one call option at the same strike.  Thus the buyer of an at the money protective put is, in reality, changing the portfolio from long stock to long ATM calls.

Alternative c) also finds the investor owning an all-call portfolio.  The difference is that this time the call is ITM.  The downside is protected because all that can be lost is the value of the call.

c) gives the investor a better opportunity to earn money on a continued rally because he/she owns the 70 delta call instead of the 50 delta (synthetic) call.   

d) affords better downside protection, but costs more.  The other play (c) is equivalent to buying the 30 detla put, and that is less expensive than buying the ~50 delta, at the money, put.

On re-reading this reply, it seems that I am imposing my comfort zone boundaries on this answer.  Obviously if you prefer to own the 50-delta synthetic call than the 70-delta call, how can I judge that it's the 'wrong' answer?

But please be aware that the cost is higher and that the upside is not as good.

Selling part of your portfolio is reasonable, but the real question is:  how much to sell? 


5)  In your opinion, which two of the following played the most important role in determining your past success as an option trader?

The top vote getters (the poll is still open) had nothing to do with the actual trading.  Instead they were all factors that concerned risk management:

1) Preventing large losses (32%)

2) Following a trade plan (19%)

3) Not trading too much size (23%)

That's a very pleasing result.  Market timing and predicting direction may be something that some traders can do well, but your responses tell me that you not only understand the importance of good risk management, but that you practice it and it pays off in extra income.

Thank you for participating


Learned a great deal from your book.  This is especially true regarding Equivalent Positions.  Your chapter was the clearest explanation that I have ever read.  Thank you for making the effort to put out such a fine book." DS


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7 Responses to Quiz Answers

  1. Julien 10/11/2010 at 5:47 AM #

    Thank you Mark. Your blog continues to provide an engaging educational experience for us options traders. Quizzes are a wonderful way to track ones own knowledge.

  2. Mark Wolfinger 10/11/2010 at 9:56 AM #


  3. Peter 10/12/2010 at 4:34 AM #

    If you purchase the put for protection, when would you decide to take it off? In general, I don’t like married put (synthetic call) positions for investment. I might purchase a wide, vertical put spread instead of a naked put to reduce the cost. I might also sell an OTM covered call, or maybe a vertical call spread if I don’t want to cap the upside potential. Peter

  4. Mark Wolfinger 10/12/2010 at 7:32 AM #

    I loathe the married put. Investors who adopt that approach recognize neither the huge cost nor the true nature of the positon they own: The synthetic call.
    You would ‘take it off’ at any time that you no longer wanted your portfolio to consist owning calls. Perhaps after so much time has passed, or your market outlook has changed, or the stock price has undergone a significant change.
    NOTE: None of the alternative ‘protection’ ideas that you suggested afford the same protection as buying a put. Yes, they are less costly, provide some protection, but if you want protection, those are not going to do you much good in a debacle.
    If you want unlimited upside, and protection, then it’s necessary to decide the type of protection to buy. That’s why I preferred the alternative reply of owning ITM calls. I’d rather pay for the 30 delta put than the 50 delta put – if I had a portfolio to protect.
    But these are all personal decisions and this is not a one size fits all investing dilemma.

  5. Peter 10/12/2010 at 8:07 AM #

    On CNBC, I hear many times: stocks are up, VIX is low, puts are cheap, so it’s a good time to buy some put protection. If the market drifts higher or remains flat, then what? You have a decaying asset; do you take the hedge off based on your gut feel, forecast, specific price/time…? I hear the putting on part, but hardly ever the taking off – which was the reason for my question.
    Your initial Question 4 was concerned about protecting your profit from a run-up from May 2010 and the possibility of earning much more if the market continues upwards. I think the put spread fits the bill nicely. For example, if SPY moved from 108 to 116 during that time, you could purchase the 116P/108P (or maybe lower strike) vertical spread which would protect the run-up amount. Of course it doesn’t provide the full protection of a naked long put, but I think it’s a good compromise (probably because I like the put-spread collar as an investment strategy).

  6. Mark Wolfinger 10/12/2010 at 8:31 AM #

    1) ‘Taking off?’ Do you ever hear TV talking heads refer to exiting a trade? When they make a recommendation, it’s apparently a forever trade. The only exception is that the talking head may – at some future date – tell you that the stock is now on his list of stocks to sell – with no explanation of how it got there.
    So don’t look for ‘talking advice’ from that awful TV station.
    If I were you, I’d get any advice elsewhere.
    I don’t really have a good answer. Here’s why: I don’t know why you bought the puts, so don’t know your goal when seeking protection. If you bought because ‘puts are cheap’ (believe me, these CNBC people have no idea when puts are cheap or costly) then sell them when puts are no longer cheap. In other words, if the reason that made you buy the puts no longer exists, why own them?
    It’s the same as with any trade. You buy something and sell it when you no longer want to own it.
    On the other hand, if you truly believe that you want to own insurance at all times, then never sell it. Keep the insurance and pay the price. I really don’t know what else to tell you.
    I own insurance, but only when I deem it necessary.
    2) Yes, the put spread affords protection, but it’s limited, and is a good compromise.
    In my opinion, most individual investors know so little about options in the first place that I was looking for the simplest solutions. The put spread does give you what you pay for. Less protection at a reduced cost.

  7. Peter 10/12/2010 at 9:09 AM #

    I know. Not to worry, I watch CNBC for stocks to put on my watchlist to analyze later, and a bit just for entertainment while I watch the market. I think CNBC does a tremendous disservice to the regular investor, especially recommendations by short-term traders of getting into a specific trade without follow-up.
    Thanks for the conversation.