I was just looking around at the OX site and started their level 4! options quiz for the fun of it. I thought most questions were actually pretty easy, but this one didn't quite seem to have the answer I would have thought. Q. Which of the following is a characteristic of a "Debit Spread"? 1. Bullish debit spreads allow an unlimited potential return. 2. Selling an option at-the-money give you enough to buy a lower strike price call to cover the position. 3. Can be used to purchase stock later without the need for cash up-front. 4. Traders often employ Debit spreads to protect stock they currently own. Several of these choices are clearly very incorrect, but I didn't like any of the answers. I did get it right however . I put a picture of the question and then the answer in the attachment if you want to see it. I don't want to give away the answer here at first, but any comments? Do you think the answer is odd as well (not that the other ones are correct)? I would have thought the answer would have been something like "can profit in a correct directional move, but profits are limited". JJacksET4
No opinions? Comments? Maybe I'm wrong to think this is odd? Maybe I'm missing something? Or maybe not? JJacksET4
Yeah, I thought it was odd. And I didn't really like the choices either. You can eliminate 1&2. So, it boils down to 3&4. Since I use spreads for hedging I chose 4 rather too quickly - and was wrong! I think that the key is in the phrasing. "Can be used" vs. "Traders often employ" and the key word "protect." Do traders often employ debit spreads to hedge stock - no, I guess not. Does the debit "protect" stock? Well, it's a weak hedge - some protection, but doesn't protect like a long put. But can be used to purchase stock? Maybe, but if the spread's ITM you have to buy back the short, and then, technically, it isn't the spread that is used for the purchase. Of course, if only the long is ITM at expiry, then yes it "can be used" to purchase stock. (dammit) No sir, don't like it - don't like it at all.
?....with (3), to exercise the long-call leg of the debit spread in order to purchase the underlying stock makes logical "sense". (1) and (2) are obviously wrong. (4) isn't totally true.
Yep, basically how I felt. I wouldn't consider a debit spread a good idea to be able to buy stock in the future - what if the stock soars? Like you said, it's really the long call doing the work, not the spread. I recognized the "No sir, don't like it - don't like it at all" quote but I couldn't quite put my finger on it so I had to look it up - Ren and Stimpy. I remember that now . JJacksET4