Securities Trader Representative (Series 57) Practice Exam

In a bear spread, which option is typically sold?

1. The option with the higher exercise price

2. The option with the lower exercise price

3. Both options at market price

4. None of the options

The correct answer is: The option with the lower exercise price

In a bear spread strategy, an investor is betting on a decline in the price of the underlying asset. To construct this strategy, the investor will typically sell the option with the lower exercise price and buy the option with the higher exercise price. By selling the option with the lower exercise price, the investor can collect a premium that helps to offset the cost of purchasing the more expensive, higher exercise price option. This setup limits both potential losses and potential gains, making it a defined risk strategy. In this context, the choice to sell the option with the lower exercise price is crucial because it allows the trader to profit from a decrease in the underlying asset's price while managing risk. As the price of the underlying asset declines, the sold lower strike option will ideally expire worthless or generate a smaller loss compared to the profit gained on the higher strike option. Therefore, identifying and selecting the correct option to sell in a bear spread is essential for executing this bearish outlook effectively.