CIRO Derivatives: Element 6 — Derivatives Strategies

Try 10 focused CIRO Derivatives questions on Element 6 — Derivatives Strategies, with answers and explanations, then continue with Securities Prep.

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Sample questions

These questions are original Securities Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.

Question 1

Topic: Element 6 — Derivatives Strategies

A client is considering listed options on ABC Corp., trading at $60 on the Bourse de Montreal. One contract covers 100 shares, and all premiums are in CAD.

Exhibit:

The client expects a sharp move over the next month but is unsure of direction, wants maximum loss limited to the premium paid, and will spend no more than $200 in total premium. Which strategy is most suitable?

• A. Buy 1 60 call and 1 60 put; net debit $450.
• B. Buy 1 60 call and sell 1 65 call; net debit $160.
• C. Sell 1 60 call and 1 60 put; net credit $450.
• D. Buy 1 65 call and 1 55 put; net debit $150.

Best answer: D

What this tests: Element 6 — Derivatives Strategies

Explanation: The best fit is the long strangle using the 65 call and 55 put. It is a non-directional long-volatility strategy, and its total premium is \((0.80+0.70)\times100=\) $150, which is within the client’s $200 budget while capping loss at the premium paid.

A client expecting a large move but not a specific direction is looking for a long volatility strategy. The long strangle matches that view and keeps the maximum loss limited to the premium paid.

• Cost per share: \(0.80+0.70=1.50\)
• Contract multiplier: \(1.50\times100=\$150\)
• Total outlay: $150, which is within the $200 limit

The at-the-money long straddle is also non-directional, but it costs \((2.40+2.10)\times100=\$450\), so it fails the budget constraint. The key is to match both the market view and the client’s risk and cost limits.

• The at-the-money long straddle matches the volatility view, but its $450 debit exceeds the stated budget.
• The short straddle brings in premium, but it creates potentially unlimited risk and does not meet the limited-loss requirement.
• The bull call spread has defined risk and fits the budget, but it requires a bullish directional view rather than uncertainty about direction.

This long strangle costs \((0.80+0.70)\times100=\) $150, fits the budget, and matches a large-move, no-direction view with limited loss.

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Question 2

Topic: Element 6 — Derivatives Strategies

A speculative client buys 4 Bourse de Montreal S&P/TSX 60 index futures contracts at 1,250.00. Each contract has a multiplier of $200 per index point and is cleared through CDCC. Later, the client offsets the position at 1,257.00. Ignoring commissions, what is the client’s profit or loss?

• A. Loss of $5,600
• B. Profit of $1,400
• C. Loss of $1,400
• D. Profit of $5,600

Best answer: D

What this tests: Element 6 — Derivatives Strategies

Explanation: This is a long futures calculation: profit equals the increase in futures price times the contract multiplier times the number of contracts. The price rose 7 index points, so the gain is \(7 \times 200 \times 4 = 5,600\), or $5,600.

For a long futures position, profit equals the change in the futures price multiplied by the contract multiplier and the number of contracts. The client bought at 1,250.00 and offset at 1,257.00, so the futures price increased by 7.00 index points. Because the position was long, that increase produces a gain.

• Gain per contract: \(7 \times 200 = 1,400\)
• Total gain on 4 contracts: \(1,400 \times 4 = 5,600\)

The result is a profit of $5,600 before commissions; a loss answer would fit a short futures position or a price decline after purchase.

• The smaller profit amount uses the gain on one contract only and ignores that four contracts were purchased.
• The smaller loss amount reverses the payoff for a long position and also misses the full contract count.
• The larger loss amount applies short-futures logic; a long futures position benefits when the futures price rises.

A long futures position gains when price rises, and \((1,257 - 1,250) \times 200 \times 4 = 5,600\), so the client earns $5,600.

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Question 3

Topic: Element 6 — Derivatives Strategies

An institutional derivatives desk at a CIRO dealer is reviewing a possible cash-and-carry arbitrage in a 2-month S&P/TSX 60 futures contract on the Bourse de Montreal. The index is 1,250 and the contract multiplier is 200. Financing and other carry costs to expiry are 18 index points, expected dividends are 6 points, and total execution costs for both legs are 4 points. The futures is trading at 1,278. After confirming the client is authorized for the strategy, what is the best next step?

• A. Wait because the mispricing is not profitable after costs.
• B. Buy the index basket and sell the futures simultaneously; about $2,400.
• C. Sell the futures now and complete the cash leg later if needed.
• D. Sell the index basket and buy the futures simultaneously; about $2,400.

Best answer: B

What this tests: Element 6 — Derivatives Strategies

Explanation: This is a cash-and-carry arbitrage. Fair value is 1,262 points, so a futures price of 1,278 is rich by 16 points; after 4 points of execution costs, the net spread is 12 points, or $2,400 per contract, by buying the basket and selling the futures together.

Use the futures fair-value test first, then choose the matching arbitrage sequence. Fair value equals spot plus carry costs minus expected dividends. Here, the fair value is below the market futures price, so the futures contract is overpriced and the proper trade is cash-and-carry: buy the underlying basket and sell the futures at the same time.

\[ \begin{aligned} \text{Fair value} &= 1,250 + 18 - 6 = 1,262 \\ \text{Net spread} &= 1,278 - 1,262 - 4 = 12\text{ points} \\ \text{Profit per contract} &= 12 \times 200 = 2,400\text{ CAD} \end{aligned} \]

Entering only one leg would leave basis risk instead of locking in arbitrage, and reversing the trade direction would bet on the wrong pricing relationship.

• Reverse direction fails because an overpriced futures contract calls for buying cash and selling futures, not selling cash and buying futures.
• One leg first fails because delaying the offsetting cash trade turns an arbitrage into an exposed speculative position.
• No opportunity fails because the 16-point mispricing still leaves a positive 12-point net spread after costs.

Fair value is 1,262, so the futures is overpriced by 16 points; after 4 points of costs, buying cash and selling futures locks in 12 points, or $2,400 per contract.

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Question 4

Topic: Element 6 — Derivatives Strategies

XYZ Inc. shares are trading at $50.00. A client expects a large move after earnings, has no directional view, and wants the lower-premium long volatility strategy. All options below are listed on the Bourse de Montreal, have the same expiry, and premiums are CAD per share.

Which statement is best supported?

• A. Buy the 50 call and 50 put: lower-cost long strangle, larger move needed.
• B. Buy the 55 call and 45 put: lower-cost long strangle, larger move needed.
• C. Sell the 55 call and 45 put: limited-risk short strangle.
• D. Buy the 55 call and 45 put: lower-cost long strangle, smaller move needed.

Best answer: B

What this tests: Element 6 — Derivatives Strategies

Explanation: The 55 call plus 45 put is a long strangle. It costs less upfront than the 50-strike long straddle, but because the strikes are farther from the current share price, the stock must move farther before the position breaks even.

A long strangle is created by buying an out-of-the-money call and an out-of-the-money put with the same expiry. Here, the 55 call and 45 put cost \(1.20 + 1.40 = 2.60\) per share. A long straddle uses the same-strike call and put, so the 50 call and 50 put cost \(3.40 + 3.40 = 6.80\) per share.

• Long 50 straddle break-evens: $43.20 and $56.80
• Long 45/55 strangle break-evens: $42.40 and $57.60

The strangle is cheaper, but its break-evens are farther from the current $50.00 share price, so it needs a larger move to profit. The closest trap is confusing the cheaper out-of-the-money combination with a straddle; it is a strangle.

• Same strike confusion fails because the 50 call plus 50 put is a straddle, not a strangle.
• Short volatility mix-up fails because selling the 55 call and 45 put is a short strangle, and its risk is not limited to the premium received.
• Break-even reversal fails because the 45/55 long strangle needs a larger move than the 50-strike long straddle, not a smaller one.

That combination is the long strangle; it costs 2.60 per share and breaks even farther from $50.00 than the 50-strike long straddle.

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Question 5

Topic: Element 6 — Derivatives Strategies

All amounts are in CAD. A trader at a Canadian investment dealer reviews a 3-month OTC forward on a non-dividend-paying stock. The stock is trading at $50.00 per share, and the 3-month financing cost is $0.75 per share, so the no-arbitrage forward price is $50.75. The quoted forward price is $52.25. Ignore transaction costs and counterparty credit risk. Which statement is INCORRECT?

• A. The gross arbitrage spread is about $1.50 per share.
• B. Shorting the stock and buying the forward is appropriate.
• C. Buying the stock and selling the forward is appropriate.
• D. The forward is overpriced versus no-arbitrage value.

Best answer: B

What this tests: Element 6 — Derivatives Strategies

Explanation: When a forward trades above its no-arbitrage value, the correct arbitrage is cash-and-carry. The trader buys the underlying now, finances the purchase, and sells the forward; here that locks in a gross spread of about $1.50 per share before costs.

The key is to compare the market forward price with the no-arbitrage forward price. Here, fair value is $50.75 and the quoted forward is $52.25, so the forward is overpriced by $1.50. That means the appropriate arbitrage is cash-and-carry, not reverse cash-and-carry.

• Buy the stock in the spot market.
• Finance the purchase for 3 months.
• Sell the forward at $52.25.

At expiry, the stock is delivered into the forward, the financing is repaid, and the $1.50 gross spread per share is locked in before costs. The opposite trade is used when the forward is too cheap.

• Overpriced forward is accurate because the market quote exceeds the no-arbitrage price.
• Buy spot, sell forward matches a cash-and-carry arbitrage when the forward is rich.
• $1.50 spread is accurate because $52.25 minus $50.75 equals $1.50.
• Short spot, buy forward describes reverse cash-and-carry, which fits an underpriced forward, not this scenario.

That trade is reverse cash-and-carry, which is appropriate when the forward is underpriced, not overpriced.

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Question 6

Topic: Element 6 — Derivatives Strategies

A client with a derivatives account expects Maple Bank shares, now at $60, to rise modestly over the next two months but likely stay below $65. The client wants bullish exposure with a known maximum loss and accepts limited upside if it reduces the net premium. Which Bourse de Montreal-listed option strategy is most suitable?

• A. Buy the two-month $60 call.
• B. Buy the two-month $60 call and sell the two-month $65 call.
• C. Buy the two-month $60 call and buy the two-month $60 put.
• D. Sell the two-month $60 put uncovered.

Best answer: B

What this tests: Element 6 — Derivatives Strategies

Explanation: A bull call spread fits a moderately bullish view when the client accepts a ceiling on gains in exchange for lower cost. Buying the lower-strike call and selling the higher-strike call creates defined risk and cheaper upside exposure than a long call alone.

The key tradeoff is limited upside for lower entry cost. A bull call spread is designed for a moderate rise, not an unlimited rally. Buying the $60 call gives upside participation above $60, while selling the $65 call brings in premium that lowers the net debit and therefore lowers the maximum possible loss to the net premium paid. That matches the client’s stated need for defined risk and lower cost, and the expected price range makes the upside cap acceptable.

• Best when the expected rise is positive but limited.
• Maximum loss is the net premium paid.
• Maximum profit is capped once the shares are at or above $65 at expiry.

A long call is the closest alternative, but it costs more and does not use the client’s willingness to cap upside.

• Long call only preserves unlimited upside, but it does not deliver the lower-premium tradeoff the client wants.
• Uncovered short put is bullish, but its downside risk is large and not limited to a known debit.
• Long straddle is a volatility strategy that needs a large move in either direction, not a modest rise below $65.

This bull call spread matches a modest bullish view by reducing net premium and defining maximum loss, while capping gains above $65.

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Question 7

Topic: Element 6 — Derivatives Strategies

In a client’s derivatives account, an Approved Person discusses a bull call spread using listed options on the Bourse de Montreal: buy one September ABC 50 call and sell one September ABC 55 call, same expiry. The client wants a lower net premium than buying the 50 call alone. What is the primary tradeoff of this strategy?

• A. The downside loss becomes unlimited if ABC falls.
• B. The position is exposed to daily variation margin.
• C. The upside profit is capped above the 55 strike.
• D. The strategy depends mainly on a volatility spike.

Best answer: C

What this tests: Element 6 — Derivatives Strategies

Explanation: A bull call spread lowers the cost of a bullish view by selling a higher-strike call against a lower-strike long call. The tradeoff is capped upside: after the stock rises above the short strike, extra gains on the long call are offset by the short call.

A bull call spread is a vertical debit spread: long the lower-strike call and short the higher-strike call with the same expiry. The short call helps finance the long call, so the client pays less premium than for an outright long call. The main limitation is that profit stops increasing once ABC moves above the 55 strike, because gains on the 50 call are then offset by losses on the written 55 call. That makes the strategy appropriate for a moderate bullish view, not for a client expecting unlimited upside. The key tradeoff versus buying the 50 call alone is lower upfront cost in exchange for a capped maximum profit.

• Unlimited loss fails because a debit bull call spread can lose no more than the net premium paid.
• Variation margin fails because this is not a futures-style position whose main cash-flow feature is daily mark-to-market.
• Volatility spike fails because the strategy is built for a moderate rise in the underlying, not mainly for a sharp increase in implied volatility.

Selling the higher-strike call reduces the debit, but it also stops further net gains once ABC rises above 55.

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Question 8

Topic: Element 6 — Derivatives Strategies

An Approved Person is asked to calculate a client’s profit or loss on a speculative S&P/TSX 60 index futures trade on the Bourse de Montreal. The file shows 3 contracts, a contract multiplier of CAD 200 per index point, an opening futures price of 1,248.20, and an offsetting price of 1,260.70. The screenshot does not show whether the client opened the position by buying or selling. What must be verified first?

• A. Whether the client opened by buying or selling the contracts
• B. The current level of the S&P/TSX 60 cash index
• C. The client’s initial margin deposit
• D. Whether the client is a qualified hedger

Best answer: A

What this tests: Element 6 — Derivatives Strategies

Explanation: Realized futures profit or loss requires the entry price, exit price, contract multiplier, number of contracts, and position direction. Here, everything is provided except whether the client was long or short, so the sign of the result cannot be determined until that fact is verified.

For a futures trade, the dollar result is based on the price change, the contract multiplier, the number of contracts, and whether the client first bought or first sold. In this scenario, the futures price rose from 1,248.20 to 1,260.70, so the move is 12.50 index points. With a multiplier of CAD 200 and 3 contracts, the magnitude of the result is knowable, but not whether it is a gain or a loss.

• Price change: \(1,260.70 - 1,248.20 = 12.50\) points
• Per-contract amount: \(12.50 \times 200 = 2,500\) CAD
• Total magnitude: \(2,500 \times 3 = 7,500\) CAD

If the client was long, the result is a profit of CAD 7,500; if short, it is a loss of CAD 7,500.

• Initial margin supports the position but does not determine the realized trading result.
• Cash index level may matter for basis analysis, but not for a closed futures P/L when both futures prices are given.
• Qualified hedger status affects account treatment and regulatory context, not the arithmetic of this speculative trade.

The price change, multiplier, and number of contracts are known, but profit versus loss depends on whether the position was long or short.

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Question 9

Topic: Element 6 — Derivatives Strategies

A trader at a CIRO-regulated investment dealer is evaluating a listed futures contract on a liquid Canadian ETF. Ignore transaction costs. The ETF can be bought or short sold, and the stated carry can be locked in.

Exhibit: Market snapshot

• ETF spot price: $50.00 per unit
• Net carrying cost to futures expiry: $1.20 per unit
• Futures price: $52.10 per unit

Which arbitrage is supported by the exhibit?

• A. Buy the ETF and sell the futures
• B. Buy the ETF and buy the futures
• C. Short the ETF and buy the futures
• D. Take no action because futures should trade above spot

Best answer: A

What this tests: Element 6 — Derivatives Strategies

Explanation: Use the no-arbitrage fair value: spot price plus net carrying cost to expiry. That gives $51.20, so a futures price of $52.10 is too high. The supported arbitrage is to buy the ETF in the cash market and sell the futures.

The core concept is futures fair value under no-arbitrage. When the exhibit gives spot and net carrying cost directly, the fair futures price is simply spot plus net carry to expiry.

\[ \begin{aligned} \text{Fair value} &= 50.00 + 1.20\\ &= 51.20 \end{aligned} \]

Because the quoted futures price is $52.10, the futures contract is overpriced by $0.90 per unit before transaction costs. The arbitrage is a cash-and-carry trade: buy the ETF now, carry it to expiry, and sell the futures at the inflated price. As expiry approaches, the futures and spot prices converge, allowing the trader to lock in that mispricing. The reverse trade would only make sense if the futures were below fair value.

• Reverse trade fits an underpriced futures contract, not one priced above fair value.
• Buy both sides is a directional position, not an arbitrage that locks in the pricing gap.
• No-arbitrage claim ignores the stated carrying cost; futures can be above spot and still be overpriced.

The fair futures value is $51.20, so the futures contract is overpriced and a cash-and-carry arbitrage is supported.

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Question 10

Topic: Element 6 — Derivatives Strategies

A client holds 12,000 shares of Maple Grid Inc. and wants to hedge 80% of the position for the next month using listed put options on the Bourse de Montreal. Each put contract covers 100 shares, and each put has a delta of \(-0.60\). Ignoring changes in delta, how many put contracts are needed for an approximate delta hedge? Round to the nearest whole contract.

• A. 160 put contracts
• B. 96 put contracts
• C. 58 put contracts
• D. 200 put contracts

Best answer: A

What this tests: Element 6 — Derivatives Strategies

Explanation: A delta hedge uses the option’s share-equivalent exposure, not just the contract size. Hedging 80% of 12,000 shares means covering 9,600 shares, and each put contract offsets about 60 shares because \(0.60 \times 100 = 60\). That requires \(9,600/60 = 160\) contracts.

For an approximate delta hedge, first find the portion of the stock position to hedge, then divide by the absolute delta exposure of one option contract. Here, the client wants to hedge 80% of 12,000 shares, so the target hedge is 9,600 shares. One put contract has an absolute delta of \(0.60\) on 100 shares, so one contract offsets about 60 shares of long stock exposure.

\[ \begin{aligned} \text{Shares to hedge} &= 12{,}000 \times 0.80 = 9{,}600 \\ \text{Delta per contract} &= 0.60 \times 100 = 60 \\ \text{Contracts needed} &= 9{,}600 / 60 = 160 \end{aligned} \]

Use the absolute value of the put delta for the contract count; the negative sign reflects hedge direction, not a negative number of contracts.

• 58 contracts comes from multiplying by delta instead of dividing by the contract’s delta exposure.
• 96 contracts treats each contract as a full 100-share hedge and ignores the 0.60 delta.
• 200 contracts hedges the full 12,000-share position on a delta basis and ignores the 80% target.

Because 80% of 12,000 shares is 9,600 shares, and each put offsets about \(0.60 \times 100 = 60\) shares, \(9,600/60 = 160\) contracts.

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Related focused pages

• Free CIRO Derivatives Full-Length Practice Exam
• CIRO Derivatives: Element 1 — the Client Relationship
• CIRO Derivatives: Element 2 — Regulatory Documentation
• CIRO Derivatives: Element 3 — Derivative Types and Features
• CIRO Derivatives: Element 4 — Derivative Pricing
• CIRO Derivatives: Element 5 — Derivative Trading and Settlement
• CIRO Derivatives: Element 7 — Derivative Market Integrity
• CIRO Derivatives: Element 8 — Conduct and Conflicts

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