General Securities Representative (Series 7) Practice Exam

In a spread option position, what must be different?

1. Number of contracts

2. Expiration month, exercise price, or both

3. Underlying security

4. Market volatility

The correct answer is: Expiration month, exercise price, or both

In a spread option position, the key characteristic that differentiates it from a simple long or short option position is that the options involved must have distinct expiration months, exercise prices, or a combination of both. This creates a strategy where an investor can benefit from the relative movements between the two options. When options are spread, the objective is often to capitalize on the price difference between the options as the market fluctuates. For example, in a bull call spread, an investor buys a call option with a lower strike and sells a call option with a higher strike, thus defining a risk and return profile. By having different expiration months or exercise prices, the investor can respond dynamically to market conditions while managing risk effectively. Other factors like the number of contracts, underlying security, and market volatility can influence an option position but do not necessarily define the spread itself. Different strategies can involve the same number of contracts or the same underlying security if they adhere to different expiration months or exercise prices. Hence, the requirement for differing expiration months, exercise prices, or both is fundamental to establishing a spread option position.