Series 66: Derivatives Suitability Practice Flashcards

This set of vocabulary flashcards covers key derivative strategies, suitability profiles, and hedging concepts from the Series 66 exam transcript.

Derivative Suitability for Retail Investors

Generally unsuitable for most investors because of significant/unlimited risk or the high probability of losing $100\%$ of the invested premium in short periods.

Long Call Investment Objective

Speculative growth (capital gains/appreciation) for an aggressive investor with a bullish market outlook.

Max Loss on Long Calls and Long Puts

Limited to $100\%$ of the premium paid.

Long Put Investment Objective

Speculative growth (capital gains/appreciation) for an aggressive investor with a bearish market outlook.

Net Gain/Loss Formula on Exercised Long Call

$$\text{(Market Price at Liquidation - Strike Price - Premium Paid)} \times \text{(Number of Shares)}$$

Short Naked Call

A strategy used for speculative income with a neutral to bearish outlook; it carries unlimited risk and is suitable only for aggressive investors with very high risk tolerance.

Short Naked Put

A strategy used for speculative income with a neutral to bullish outlook; it carries significant risk calculated as $\text{(Strike Price - Premium)} \times \text{Shares}$.

Long Stock + Long Put

A hedging strategy used to protect a long stock position against downside market drops, functioning like insurance.

Short Stock + Long Call

A hedging strategy used to protect a short stock position against upside market price spikes.

Long Option Hedge vs. Sell Stop Order

A Long Option Hedge requires paying a premium and offers flexibility, while a Stop Order has no extra cost beyond commissions but triggers automatically without flexibility.

Index Options

Used to hedge broad market or portfolio risk (including mutual funds), such as buying S&P 500 put options to offset losses from a market decline.

Covered Call

A strategy involving Long Stock + Short Call to generate income in a flat/neutral short-term market; primary risks are opportunity cost and stock downside risk.

Covered Put

A strategy involving Short Stock + Short Put used for income in flat/neutral markets; it is unsuitable for conservative investors due to the unlimited risk of the underlying short stock.

Futures Contracts

Standardized, exchange-traded, and liquid instruments used for both hedging and speculation on commodity prices.

Forward Contracts

Customized, non-traded/OTC contracts mainly used by commercial entities planning for physical delivery/takeover to hedge price risk.