Free CISI IAD Derivatives Practice Questions: Trading, Hedging, and Investment Strategies

CISI means Chartered Institute for Securities & Investment. IAD means Investment Advice Diploma, and this page is for the Derivatives unit. Use this focused CISI IAD Derivatives page as a short practice test for Trading, Hedging, and Investment Strategies. The items are original Finance Prep sample exam questions built for scenario-based practice, not trivia, puzzle questions, official CISI questions, copied live-exam content, or exam dumps.

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Sample questions

These are original Finance Prep practice questions aligned to this topic area. They are not official CISI questions, copied live-exam content, or exam dumps. Use them to preview question style and explanation depth before continuing with topic drills, mixed sets, and timed mock exams in Finance Prep.

Question 1

Topic: Trading, Hedging, and Investment Strategies

A UK retail client has £80,000 outside an ISA or SIPP and wants low-cost indirect exposure to the S&P 500 for about four years. She wants daily dealing on a retail platform, no personal margin calls, and no geared payoff. She is willing to accept swap counterparty exposure inside a fund, but does not want a capital-protected product with capped participation. Her adviser has established that disposals of reporting funds would be taxed under UK capital gains rules, whereas gains on a non-reporting offshore fund would be taxed as income. Which investment route is most suitable?

• A. A five-year capital-protected structured note linked to the S&P 500 with capped upside participation.
• B. A 2x daily leveraged S&P 500 ETF that resets its exposure at each trading close.
• C. A non-reporting offshore hedge fund using index futures and options with quarterly redemptions and performance fees.
• D. A UK-reporting UCITS synthetic ETF using a total return swap for 1x index exposure.

Best answer: D

What this tests: Trading, Hedging, and Investment Strategies

Explanation: The client wants an indirect derivative-enhanced investment, but not a speculative geared product, a personal derivatives account, or a capital-protected structured note. A synthetic ETF can obtain index exposure through a swap held inside the fund, so the investor buys fund units rather than meeting futures or CFD margin calls personally. UCITS and retail-platform access support daily dealing and relatively low costs. The stated UK reporting status is also decisive because it aligns gains on disposal with UK capital gains treatment in the scenario. The alternatives each fail a key fact: offshore non-reporting funds may be less liquid, more costly, and taxed less favourably; capital-protected notes introduce issuer risk and capped participation; leveraged ETFs are designed for geared, often short-term exposure.

• The offshore hedge fund conflicts with the liquidity, cost, retail-access, and tax preferences stated.
• The capital-protected structured note gives a protected payoff profile the client does not want and usually caps upside.
• The leveraged ETF is still indirect, but its 2x daily reset creates geared exposure and compounding risk.

It provides pooled, retail-accessible synthetic exposure without personal margin calls or gearing, and its reporting status fits the stated tax preference.

Question 2

Topic: Trading, Hedging, and Investment Strategies

A derivatives adviser is considering a six-week strategy on a listed equity currently trading at 500p. A regulatory decision is due before expiry, and the adviser expects a sharp move but has no view on direction. The client does not own the shares, wants the maximum loss fixed at the initial premium, and is prepared to pay a higher premium if the strategy responds strongly to a move away from 500p.

Which strategy is the single best match?

• A. Buy a 540p call and buy a 460p put with the same expiry.
• B. Sell a 500p call and sell a 500p put with the same expiry.
• C. Buy the shares and sell a 500p call with the same expiry.
• D. Buy a 500p call and buy a 500p put with the same expiry.

Best answer: D

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A long straddle is normally used when a substantial price move is expected but the direction is uncertain. It involves buying a call and buying a put on the same underlying, with the same strike and expiry. Here, the current price is 500p and the client wants a strategy that benefits from a large movement away from that level while keeping the maximum loss to the premium paid. Because both options are bought, the downside is defined. The at-the-money construction also gives stronger sensitivity to movement around the current price than an out-of-the-money strangle, although it costs more in premium. That fits the client’s willingness to pay a higher premium for stronger exposure to volatility.

• A short straddle receives premium, but it is damaged by a sharp move and can create very large losses.
• A long out-of-the-money strangle also benefits from volatility, but it needs a larger move and is less responsive near 500p.
• A covered call is an income strategy with directional share exposure, not a defined-loss volatility strategy for a client holding no shares.

A long at-the-money straddle gives exposure to a large move in either direction with the loss limited to the two premiums paid.

Question 3

Topic: Trading, Hedging, and Investment Strategies

A derivatives adviser is reviewing an equity index options strategy for a client.

• The client wants upside exposure to the FTSE 100 over the next three months.
• The market view is a moderate rise, not a sharp rally.
• The client wants a lower initial premium than buying an at-the-money call outright.
• The client accepts giving up gains above a target index level in exchange for defined risk.

Which strategy and risk description is the single best fit?

• A. Buy a lower-strike three-month call and sell a higher-strike three-month call; the net premium is reduced, maximum loss is defined, and profit is capped above the higher strike.
• B. Buy a lower-strike six-month call and sell a higher-strike three-month call; the different expiries make the position lower risk than a same-expiry spread.
• C. Buy a three-month at-the-money call and sell a one-month at-the-money call; the position removes the upside cap while locking in premium income.
• D. Buy a higher-strike three-month put and sell a lower-strike three-month put; the position profits from a moderate rise while limiting loss to the net premium.

Best answer: A

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A vertical spread uses options with the same expiry but different strikes. For a moderately bullish view, a bull call spread is commonly used: buy the lower-strike call and sell the higher-strike call. The sold call helps finance the bought call, reducing the net premium and defining the maximum loss as the net premium paid. The trade-off is that gains are capped once the underlying rises above the higher strike. This fits a client who wants limited-risk upside exposure but is willing to sacrifice participation in a sharp rally. Calendar and diagonal spreads introduce expiry mismatch and time-decay considerations, which are not the main need here. A put spread is directionally unsuitable for a bullish equity index view.

• A calendar call spread depends heavily on time decay, volatility, and rolling risk; it does not remove upside limitations or guarantee income.
• A bear put spread benefits from a fall in the underlying, so it conflicts with a moderately bullish market view.
• A diagonal call spread has different strikes and expiries, adding term-structure and roll risks rather than automatically reducing risk.

A bull call vertical spread fits a moderately bullish view by reducing premium outlay while accepting a capped upside.

Question 4

Topic: Trading, Hedging, and Investment Strategies

A dealer is advising a commodities client on a Brent crude futures strategy. The client expects a temporary supply squeeze over the next two months, so the near-month Brent contract should rise relative to the six-month contract. The client does not want a large outright long oil position. Which strategy best matches the client’s motivation?

• A. Sell both the near-month and six-month Brent futures to protect against a general fall in crude oil prices.
• B. Sell the near-month Brent future and buy the six-month Brent future to profit if the near-month contract weakens relative to the deferred contract.
• C. Buy the near-month Brent future and sell the six-month Brent future to profit if the spread between them widens in favour of the near month.
• D. Buy both the near-month and six-month Brent futures to maximise gains from a general rise in crude oil prices.

Best answer: C

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A futures spread trade is used when the main view is on the price relationship between two contracts rather than the outright direction of the underlying asset. Here, the expected market condition is short-term tightness, so the near-month Brent future is expected to strengthen compared with the six-month future. Buying the near contract and selling the deferred contract creates a calendar spread that benefits if the near-month price rises relative to the later-month price. The short deferred leg helps offset some general crude oil price movement, so the strategy is more targeted than simply buying oil futures outright.

• Selling the near-month and buying the deferred future would express the opposite view: a weakening prompt contract or a flattening/reversal of near-term tightness.
• Buying both futures creates an outright long exposure to crude oil, not a spread focused on relative contract-month movement.
• Selling both futures creates an outright short exposure and is inconsistent with the expectation of near-term supply tightness.

A long near-month/short deferred calendar spread targets relative strengthening of the prompt contract while reducing outright oil price exposure.

Question 5

Topic: Trading, Hedging, and Investment Strategies

A portfolio manager is considering NYMEX crude oil futures. The manager expects the nearby contract to strengthen relative to the deferred contract, but has no clear view on the absolute direction of crude oil prices.

The contract size is 1,000 barrels. The manager expects the June-minus-December spread to move from its current level to -$1 per barrel. Which trade is most appropriate?

• A. Sell December futures outright, targeting profit only if the December futures price falls.
• B. Buy June futures outright, targeting profit only if the June futures price rises.
• C. Sell June futures and buy December futures, targeting profit if the June-minus-December spread widens further.
• D. Buy June futures and sell December futures, targeting about $3,000 profit per spread if the spread view is correct.

Best answer: D

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A futures spread is usually more suitable than an outright futures position when the trading view is about the relative movement between two contracts rather than the overall market direction. Here, the current June-minus-December spread is $78 - $82 = -$4. The expected spread is -$1, so the spread is expected to increase by $3 per barrel. Buying June and selling December profits from that increase: $3 × 1,000 barrels = $3,000 before costs and margin effects. An outright long or short futures trade would add unnecessary exposure to the absolute direction of crude oil prices, which is not the manager’s stated view.

• Buying June outright depends on a rise in the June price, not merely on June outperforming December.
• Selling December outright depends on a fall in the December price, which is not the stated view.
• Selling June and buying December is the reverse spread; it would benefit if June weakened relative to December.

The June-minus-December spread is expected to rise from -$4 to -$1, so a long June/short December spread gains $3 per barrel, or $3,000 per spread.

Question 6

Topic: Trading, Hedging, and Investment Strategies

A high-net-worth client holds a £4 million diversified UK equity portfolio. The client expects to keep the shares for at least 12 months, wants protection if the market falls by more than about 10%, wants to retain upside participation, and does not want daily variation margin calls. The portfolio is similar to, but not identical with, the FTSE 100. Which strategy best applies the relevant derivatives principle to the client’s objective?

• A. Buy a daily leveraged inverse FTSE 100 ETF equal to the portfolio value and hold it for 12 months.
• B. Sell FTSE 100 futures with notional exposure close to the portfolio value and roll the hedge until the review date.
• C. Buy 12-month FTSE 100 put options with strikes near 90% of the current index level and notional exposure close to the portfolio value.
• D. Sell out-of-the-money FTSE 100 call options to earn premium against the portfolio.

Best answer: C

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A long put is the cleanest hedge for a client who wants a downside floor, continued upside participation, and no daily variation margin calls. The client pays an option premium, but the payoff rises as the referenced index falls below the strike. Because the client’s portfolio is only similar to the FTSE 100, the protection is not exact: the hedge is exposed to basis risk if the portfolio and index move differently. That risk is still more consistent with the stated objective than using a route that removes upside, adds leverage, or provides income without downside protection.

• Short futures can reduce equity-market exposure, but they also offset upside gains and create daily variation margin cash flows.
• A daily leveraged inverse ETF is not a precise 12-month hedge because leverage and daily rebalancing can create material tracking differences.
• Selling calls generates premium and caps upside, but it does not create a floor against a market fall.

A protective index put gives downside protection with known premium cost while retaining upside, although the imperfect match creates basis risk.

Question 7

Topic: Trading, Hedging, and Investment Strategies

A derivatives adviser is considering a one-month options strategy for a professional client. The underlying share is trading at 500p. The client expects a large price move after a court ruling but has no reliable view on direction. The client wants the maximum loss to be known at outset and is willing to pay option premium for that protection. Which strategy is most appropriate?

• A. Sell a 500p call and sell a 500p put with the same one-month expiry.
• B. Buy a 500p call and sell a 500p put with the same one-month expiry.
• C. Buy a 500p call and buy a 500p put with the same one-month expiry.
• D. Sell a 500p call and buy a 500p put with the same one-month expiry.

Best answer: C

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A long straddle involves buying a call and a put on the same underlying, with the same strike and expiry. It is used when the investor expects high volatility or a large price move but is uncertain about direction. The position can profit from a sufficiently large rise through the call or a sufficiently large fall through the put. The maximum loss is the total premium paid. A short straddle is the opposite: it benefits if the underlying stays near the strike and volatility is lower than expected, but it can create very large losses if the market moves sharply.

• Selling both options is a short straddle, which suits a low-volatility or range-bound view, not an expected large move.
• Buying the call and selling the put creates bullish directional exposure, so it does not match the no-directional-view fact.
• Selling the call and buying the put creates bearish directional exposure, so it does not match the no-directional-view fact.

A long at-the-money straddle benefits from a large move in either direction and limits the maximum loss to the two premiums paid.

Question 8

Topic: Trading, Hedging, and Investment Strategies

An investor has the following equity option positions on the same share. Each option contract is over 1,000 shares.

Using delta, what is the investor’s net position in the underlying share?

• A. Long 13,500 shares
• B. Long 3,700 shares
• C. Long 6,500 shares
• D. Short 6,500 shares

Best answer: C

What this tests: Trading, Hedging, and Investment Strategies

Explanation: Delta measures the approximate change in an option position for a one-unit move in the underlying and can be used to express option holdings as an equivalent position in the underlying. Long calls have positive delta exposure. A short put reverses the negative put delta, so it creates positive delta exposure. A short call reverses the positive call delta, so it creates negative delta exposure. The calculation is: long calls \(12 \times 0.60 \times 1,000 = 7,200\), short puts \(8 \times 0.35 \times 1,000 = 2,800\), and short calls \(-5 \times 0.70 \times 1,000 = -3,500\). The net is \(+6,500\), so the investor is net long the equivalent of 6,500 shares.

• Treating the short puts as negative exposure understates the long delta position.
• Reversing the final sign gives a short exposure, but the net delta is positive.
• Adding all absolute deltas ignores that short calls reduce delta exposure.

The net delta is \((12 \times 0.60 + 8 \times 0.35 - 5 \times 0.70) \times 1,000 = +6,500\), giving a net long exposure.

Question 9

Topic: Trading, Hedging, and Investment Strategies

An adviser is reviewing a proposed derivatives overlay for a portfolio that wants the expiry payoff of being long a six-month cash-settled forward on the FTSE 100 index with a forward price of 7,500. The dealing desk can trade European options on the same index and proposes to buy a six-month 7,500 call and sell a six-month 7,500 put. Both options have the same expiry and will be held to expiry. Ignore dividends, funding, and dealing costs. Which assessment is the single best answer?

• A. The structure replicates a long forward at 7,500 because it gains above 7,500 and loses below 7,500 at expiry.
• B. The structure is a protective put because the put offsets losses on the call below 7,500.
• C. The structure is a long straddle because it uses a call and a put with the same strike and expiry.
• D. The structure replicates a short forward at 7,500 because the sold put creates the dominant expiry exposure.

Best answer: A

What this tests: Trading, Hedging, and Investment Strategies

Explanation: Put-call parity links calls, puts, the underlying exposure, and the exercise price. For expiry payoff purposes, buying a call and selling a put with the same underlying, strike, and maturity creates a synthetic long forward. If the FTSE 100 finishes above 7,500, the call is in the money and the put expires worthless, giving a positive payoff. If it finishes below 7,500, the call expires worthless and the short put creates a loss. That is the same directional payoff as agreeing to buy the index at 7,500 for cash settlement at expiry.

• Selling the put does not make the position short overall; the combination of long call and short put is long forward exposure.
• A long straddle requires buying both the call and the put, so it would benefit from large moves in either direction.
• A protective put requires owning or being long the underlying exposure and buying a put for downside protection; here the put is sold.

A long call plus a short put with the same underlying, strike, and expiry produces the expiry payoff of a long forward: index level minus 7,500.

Question 10

Topic: Trading, Hedging, and Investment Strategies

A client enters the following position on an equity index futures contract:

• Long one June futures contract at 5,000
• Long one June put option on the same futures contract, strike 5,000
• Put premium paid: 80 index points
• Contract multiplier: £10 per index point
• June futures settlement at expiry: 5,180

Ignoring commissions and financing, which description and net outcome are correct?

• A. A synthetic long put with a net loss of £800
• B. A synthetic long call with a net profit of £1,000
• C. A synthetic short call with a net loss of £1,000
• D. A synthetic long futures position with a net profit of £1,800

Best answer: B

What this tests: Trading, Hedging, and Investment Strategies

Explanation: A long futures position combined with a long put at the same strike and expiry creates a synthetic long call. If the futures price rises, the futures gain is retained and the put expires out of the money. If the futures price falls, the put offsets the futures loss below the strike, giving the protective payoff shape of a call after allowing for the premium. Here the futures gain is 5,180 - 5,000 = 180 points. The put has no intrinsic value at expiry because settlement is above the 5,000 strike. After deducting the 80-point premium, the net gain is 100 points. With a £10 multiplier, the net profit is £1,000.

• Treating the package as a simple long futures position ignores the long put and the premium paid.
• Calling it a synthetic long put reverses the construction; a long put can be replicated by a long call plus a short futures position.
• A synthetic short call would involve the opposite exposure, not a long futures position protected by a long put.

The long futures plus long put replicates a long call, and the 180-point futures gain less the 80-point premium gives 100 points times £10 = £1,000.

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