Series 7 Exam Question 235: Answer and Explanation

Question: 235

Michael Moneybags purchased 1,000 shares of WOW common stock at $26 per share. Six months later, WOW is trading at $60 and Michael expects a slight decline in the market price for a short period of time. However, Michael has a lot of confidence that WOW is a great company and he remains bullish on WOW's common stock overall. Providing Michael is correct in his assessment, which of the following positions would provide Michael a level of protection while still being able to generate additional income?

• A. Sell 1,000 WOW short and purchase 10 WOW Dec 65 calls for $300 each
• B. Buy 10 WOW straddles at 60
• C. Sell 10 WOW Dec 65 calls for $300 each and place a 1,000-share sell-stop order for WOW at 57
• D. Buy 10 WOW Oct 60 puts for $500 each

Correct Answer: C

Explanation:

C. Because Michael owns 1,000 shares of WOW stock and wants to generate additional income, he could sell covered calls against the WOW that he owns. Additionally, by placing a sell-stop order for WOW slightly below the market price, Michael is protected against a major loss if WOW drops significantly.