Securities Trader Representative (Series 57) Practice Exam

An investor who sells a July 50 put and buys a July 60 put on the same stock is establishing a:

1. Bull spread

2. Bear spread

3. Long straddle

4. Short straddle

The correct answer is: Bear spread

The situation described involves an investor selling a July 50 put and buying a July 60 put on the same stock. This strategy is categorized as a bear spread, specifically a bear put spread. In a bear spread, the investor anticipates that the price of the underlying stock will decrease. By selling the July 50 put, the investor is assuming the obligation to buy the stock at $50 if the option is exercised. Meanwhile, buying the July 60 put provides the right to sell the stock at $60. If the stock price falls below $50, the investor will incur losses when the sold put is exercised, but the purchased put will offset some of those losses since it gives the right to sell at a higher price of $60. The maximum profit occurs if the stock drops significantly below $50, allowing the sold put to be exercised and minimizes losses due to the bought put protecting against further declines. This combination of selling a lower strike and buying a higher strike put shows that the investor benefits from a decline in stock price while limiting potential losses, which characterizes a bear spread. Other strategies like a bull spread, long straddle, or short straddle involve different positions and expectations regarding the movement of the stock's price, making this