Options questions on the Series 7 exam are, let’s be honest, written to confuse those who have a good understanding of options. That’s because they want people who have a great understanding of options.
What’s the difference?
Let’s take an example question like what you’d see on the Series 7 exam.
A client has bought 1 XYZ Oct 50 call while writing a 1 XYZ Oct 53 call. The bullish contract sells for $5 and the bearish one sells for $3
What is the client’s maximum potential loss?
Even options pros will need some time to figure this out, because options require several moves to make the calculation.
However, options pros will still get to the right answer and will usually end up finding tricks to get there as fast as possible.
An options newbie will need to struggle with a MO/MI T-chart to get the answer, and that will absolutely work in this case. However, an options pro will immediately remember that this is a debit spread and thus know the max loss is the net debit paid, here $200 (the difference between the $5 purchased option and the $3 sold option multiplied by 100).
Note how simply recognizing the options play brings the expert to the right answer. In an option spread, what is important is whether it is debit or credit, so if you can identify an options play as a spread and not a straddle or combination, you can find the debit/credit value and then answer the question. But of course you’ll need to remember one extra bit of information: All debit spreads’ max loss and all credit spreads’ max gain is the net premium of the two options.
Breakevens are also pretty easy here, but you’ll have to remember another fact about options that applies not just to spreads: breakevens are found by adding premiums to lower call prices and subtracting to higher put prices. So here we don’t really need to know this is a spread but we do need to remember the rules for breakevens with calls and puts. With this knowledge, the math is easy:
Money Out Money In
$500 $300
Net premium = $200 ($2 per contract)
Lower strike price = $50
Breakeven = $53 ($50+$2)
The math is extremely easy once you know the rules and what needs to modify what.
Of course, this shortcut hasn’t got us the max gain and max loss for debit spreads and call spreads respectively. One easy way to remember this is that it’s the opposite of what we have above—max loss for debit spreads and max gain for credit spreads are the same formula, meaning max gain for debit spreads and max loss for credit spreads are currently unknown.
If you have a bad memory and are comfortable with math, memorizing the above and working out the gaps may suffice. However, if you really want to master options you need to remember another rule: spreads’ maximum potential (gain for debit, loss for credit) is the difference in strike prices minus the net premiums, again a simple calculation here:
Strike price difference = $3 (53-50)
Net premium = $2 (see above)
3-2 = $1
We know this is a debit spread (again see above) so we know this calculation is for the maximum gain, not the maximum loss.
Thus the max gain here is $100.
If this were a credit spread, $100 would be the max loss and $200 the max gain.
One of the traps many students have with options is studying charts like the following:
| Spread Position | Max Loss | Max Gain | Breakeven |
| Debit call | Net debit paid | SP delta – premium delta | Lower strike price + premium delta |
| Credit call | SP delta – premium delta | Net debit paid | Lower strike price + premium delta |
| Debit put | Net debit paid | SP delta – premium delta | Lower strike price – premium delta |
| Credit put | SP delta – premium delta | Net debit paid | Lower strike price – premium delta |
One mistake a lot of students have is that they will see a chart like this, try to memorize it, and think they have learned the major options calculations. While some students may succeed this way (not that I’ve found one who has), the vast majority will do better trying to intuit these calculations by practicing solving options problems. In doing so, the data in the chart above will become muscle memory to the point where you see the options and immediately know what basic math is needed. And those who can do that will find the Series 7 exam shockingly easy.