General Securities Representative (Series 7) Practice Exam

What distinguishes a vertical or price spread?

1. Different expiration months

2. Same strike prices

3. Different strike prices

4. Different underlying assets

The correct answer is: Different strike prices

A vertical or price spread is characterized by the use of options with different strike prices but the same expiration date. This strategy involves simultaneously buying and selling options on the same underlying asset to create a position that profits from the difference in the premiums of the options involved. When constructing a vertical spread, the trader selects options of the same type (either all calls or all puts) but varies the strike prices to take advantage of price movement in the underlying asset. This approach allows the trader to manage risk while potentially limiting losses or gains to a predetermined range, based on the spread between the strike prices of the options involved. The requirement for the options to have the same expiration date is crucial, as it ensures that the price movement of the options is correlated to the same time frame, allowing the trader to effectively forecast changes in value based on market movements. This understanding of vertical spreads is important for traders looking to engage in more sophisticated options strategies, as it enables them to navigate the nuanced risks and rewards associated with using multiple strike prices to establish a coherent market position.