Series 7 Exam Question 391: Answer and Explanation

Question: 391

Which of the following option positions provides an investor with potential premium income while limiting the maximum loss potential?

• A. Debit spread
• B. Credit spread
• C. Long straddle or long combination
• D. Short straddle or short combination

Correct Answer: B

Explanation:

B. If the investor is looking for potential premium income, they must have sold something, so you can rule out Choice (C). Because the maximum loss potential for a short straddle or short combination is unlimited and the investor wants to limit their loss, you can cross out Choice (D). Actually, the only answer that works is a credit spread. To create a credit (short) spread, the investor sells an option that will be in the money first and purchases the option that will go in the money later. If the option never goes in the money, the investor gets to keep the premium of the option sold. To limit the loss, the investor purchases an option that will go in the money later. This position provides potential premium income and limits the maximum potential loss.