Derivatives Foundation interview preparation

Questions

100

Traced to a firm

29

Firms

19

Updated

September 2026

Asked at

All firmsMSMorgan Stanley4Nomura4Akuna Capital2Amundi2HSBC2PIMCO2Bank of America1Barclays1Citadel1DRW1Goldman Sachs1Jane Street1Millennium Management1Mizuho1Old Mission Capital1RCRBC Capital Markets1Scotiabank1UBS1Wells Fargo Securities1

Topic

All topicsForwards and futures10Options basics8Option pricing7The Greeks10Volatility7Option strategies9Swaps and rates7Credit derivatives4Market structure and clearing6Indian derivatives8Trading and markets9Brainteasers6Fit9

Level

AnyCoreIntermediateHard

Type

AnyTechnicalCaseMarket viewBrainteaserFit

1. 006You run a 50 million dollar equity portfolio with a beta of 1.2. Index futures are at 5,000 with a 50 dollar multiplier. Hedge it, and tell me what you are left with.Forwards and futuresHardtechnicalEquity derivativesAsset management

   Say this

   Short 240 contracts. One contract is 5,000 times 50, so 250,000 dollars of notional. You need beta times portfolio value of index exposure, which is 1.2 times 50 million, or 60 million, and 60 million divided by 250,000 is 240. What you are left with is the alpha, plus basis risk, plus the fact that beta is an estimate.

   Then walk it

   1. Contract notional first: 5,000 index points times the 50 dollar multiplier is 250,000 dollars per contract. Always state this before dividing, because it is where candidates drop a factor.
   2. Number of contracts equals beta times portfolio value over contract notional. 1.2 times 50 million is 60 million of index-equivalent exposure; divided by 250,000 that is 240 contracts, sold.
   3. Check the hedge does what you want. If the index falls 10 percent, your book falls about 6 million on a 1.2 beta, and the short 240 contracts gain 60 million times 10 percent, which is 6 million. Flat, by construction.
   4. The minimum-variance version is more honest than beta from a regression on the wrong window: h equals the correlation times the ratio of the standard deviations, which is the same thing as the slope of portfolio returns on futures returns. Estimate it on the horizon you actually intend to hedge.
   5. What remains: idiosyncratic return, which is the point if you think you can pick stocks. Plus basis risk between the futures and the cash index, dividend risk in the futures basis, and the cash drag of posting margin.
   6. And beta drifts. It is unstable across regimes and it rises in crashes, so the hedge that looks right in calm markets under-hedges in the event you bought it for. I would re-estimate and adjust rather than set it once.

   Where candidates lose it

   Forgetting the multiplier, or hedging notional rather than beta-adjusted notional. On a 1.2 beta portfolio, hedging 50 million instead of 60 leaves you a fifth under-hedged. Say the two-step — beta-adjust, then divide by contract notional — out loud so the interviewer can follow.

   Expect next

   • Would you use futures or buy puts, and how would you choose?
   • Your beta was estimated over three years. What if the market regime just changed?
   • What is left in the portfolio after the hedge, and is that what you wanted?
2. 007A refiner wants to hedge crude purchases for the next three years but only the front months are liquid. What do you do, and what could go wrong?Forwards and futuresHardcase studyCommodities tradingCorporate treasury

   Say this

   Stack the whole exposure in the liquid front contracts and roll it forward each month, or use a smaller strip out the curve and accept a partial hedge. Either way the thing that kills you is not price — it is the funding of variation margin on a position that is economically flat.

   Then walk it

   1. The stack-and-roll: put on the full three years of notional in the front two contracts, then roll month by month. You get liquidity and a tight bid-offer, but you take the roll basis twenty-plus times.
   2. The strip alternative: sell what you can in each maturity out to three years, accepting wide spreads and a smaller hedge ratio. Less basis risk, more transaction cost, and possibly no liquidity at all beyond eighteen months.
   3. The funding problem is the real answer. Your futures leg settles in cash daily. Your physical purchases happen over three years. If crude rallies, you fund margin calls today against a benefit that arrives in 2029.
   4. This is exactly what sank Metallgesellschaft in 1993. The hedges were economically sound, but the position was stacked in the front, the curve went from backwardation to contango, and the margin calls ran to over a billion dollars. They closed the hedges near the bottom.
   5. So the practical structure: size the stack to what you can fund under a stress scenario, arrange a committed credit line specifically for margin, and pre-agree with the board what a mark-to-market loss on a hedge means, so nobody panics at the wrong moment.
   6. I would also swap some of it into an OTC commodity swap with a bank. You give up the clearing-house credit protection and pay a wider spread, but the collateral terms are negotiable under a CSA, which is precisely the problem you are trying to solve.

   Where candidates lose it

   Answering only with the mechanics of stacking and rolling. The interviewer is fishing for the funding-liquidity failure — a perfect hedge that gets closed out because of a cash call. Name Metallgesellschaft or an equivalent, and say how you would size the position to survive it.

   Expect next

   • How would you size the position so a margin call cannot force you out?
   • Would you rather hedge with an OTC swap? What do you give up?
   • How do you explain a 200 million mark-to-market loss on a hedge to a CFO?
3. 010In April 2020 WTI settled at minus 37 dollars. How can a price be negative, and how does that break the models?Forwards and futuresHardsuperdayCommodities tradingClearing and risk

   Say this

   Because WTI is physically delivered at Cushing, and if every tank is full, taking delivery costs you money. A negative price is just storage scarcity expressed as a price: holders were paying to not receive barrels they had nowhere to put. It broke two things — models that assume lognormal prices, and margin systems built on percentage moves.

   Then walk it

   1. Mechanics first: the May contract required physical delivery at Cushing. Demand had collapsed, storage was effectively sold out, and long holders facing delivery with no tank had to pay someone to take the contract.
   2. So convenience yield went sharply negative. The carry identity still holds — it is the storage term that exploded, because the marginal unit of storage was unobtainable at any price.
   3. The modelling failure: lognormal price dynamics, which is what Black-Scholes and most commodity option models assume, put zero probability on a negative price. Every option model on the screen was undefined the moment the price crossed zero.
   4. The industry response was to shift crude options to the Bachelier model, where prices are normally distributed and can go negative, and to quote volatility in dollars rather than percent. Rates desks had already done this when European yields went negative in 2015.
   5. The clearing consequence was worse. Margin models scaled to percentage moves cannot size risk on a price near zero, and several brokers had systems that could not even represent a negative price. Retail products tracking the front contract — including a large Chinese bank's oil product — took catastrophic losses.
   6. The lesson I would draw is about the delivery mechanism rather than oil. A financially settled contract on the same underlying did not go negative in the same way. Physical delivery is what converts a full tank into a price, and any contract with physical settlement can do this.

   Where candidates lose it

   Treating it as a freak event with no lesson. The point is that the model assumption — prices cannot be negative — was an assumption, not a fact, and it was load-bearing in every option pricer and margin system. Name the switch from lognormal to Bachelier.

   Expect next

   • How do you price an option when the underlying can be negative?
   • Why did the financially settled contract behave differently?
   • What should a clearing house change after an event like that?
4. 024When would you use Monte Carlo rather than a closed form or a tree, and what goes wrong with it?Option pricingHardtechnicalQuant tradingStructured products

   Say this

   Monte Carlo when the payoff is path-dependent or there are several underlyings, because both break closed forms and blow up a tree. Its weaknesses are slow convergence, difficulty with early exercise, and the fact that it will happily give you a confident answer to a badly specified model.

   Then walk it

   1. Use it for Asian options where the payoff depends on an average, barriers where it depends on whether a level was touched, and baskets or worst-of structures where the dimensionality kills a tree.
   2. A tree is fine up to two or three factors and is the right tool when you need early exercise, because you can compare continuation against exercise at every node. Monte Carlo runs forward, so American features need something like Longstaff-Schwartz regression, which is doable but adds its own error.
   3. Convergence is the headline cost. The standard error falls as one over root N, so cutting your error in half needs four times the paths. Getting a Greek to three decimal places on a complex payoff is genuinely expensive in compute.
   4. The fixes: antithetic variates, control variates where you simulate a similar payoff with a known closed form and correct by the difference, and quasi-random low-discrepancy sequences. A good control variate is often worth more than a hundred times the paths.
   5. Discretisation bias is the subtle one. Barriers are systematically mispriced by daily time steps, because the simulated path can cross and return between observations. You either use a fine grid, a Brownian bridge correction, or you accept a bias you can measure.
   6. And the real danger, which is not numerical at all: the simulation is only as good as the process you assumed. A Monte Carlo on a geometric Brownian motion gives you a precise answer to a model that has no jumps in it. Precision is not accuracy, and a tight confidence interval around a wrong model is how structured products get mispriced.

   Where candidates lose it

   Treating this as a pure numerical-methods question. The answer that lands names the American-exercise difficulty, gives a variance reduction technique by name, and finishes on model risk — a narrow confidence interval around the wrong dynamics.

   Expect next

   • How would you handle an American feature in a simulation?
   • Name a variance reduction technique and say what it buys you.
   • How would you compute a Greek in a Monte Carlo without four times the runtime?
5. 025How would you price and risk-manage a down-and-in barrier put?Option pricingHardsuperdayStructured productsEquity derivatives

   Say this

   Price it off the vanilla surface using the in-out parity relationship, then adjust for the fact that a barrier is enormously sensitive to skew and to the dynamics near the barrier. The hard part is not the price, it is that delta and gamma become discontinuous at the barrier, so the hedge is unstable exactly where you need it.

   Then walk it

   1. Start with the identity: a down-and-in put plus a down-and-out put with the same strike and barrier equals a vanilla put. That gives you a sanity check and lets you price the harder one from the easier one.
   2. The naive route is a closed form under Black-Scholes with constant volatility. It is wrong in a specific direction, because a barrier payoff depends on the whole distribution near the barrier, which is precisely where the skew lives. You have to price it on a model calibrated to the smile — local volatility at minimum, stochastic volatility if the book is big.
   3. Then the risk. Just above the barrier the knock-in has almost no value; just below it is a live vanilla put. So delta jumps, and gamma is effectively infinite at the barrier. Hedging through it means trading a large amount of stock in a market that is already moving.
   4. That discontinuity is why desks apply a barrier shift — pricing as if the barrier were slightly further away — to build in the cost of the hedging error. It is a reserve dressed up as a model input, and it should be sized to the liquidity of the underlying.
   5. Pin risk near expiry compounds it. A barrier close to spot in the last days combines the discontinuity with almost no time to hedge, which is when the losses actually happen.
   6. The commercial context worth naming: these sit inside autocallable notes sold to retail and private banking clients, which is where most barrier risk in the world lives. The client is short a knock-in put and often does not know it, and in a sharp drawdown the whole book knocks in at once — the dealers end up with correlated, one-way risk, which is exactly what happened to Korean autocallable books in early 2020.

   Where candidates lose it

   Pricing it with a Black-Scholes closed form and stopping. The interviewer wants the two hard parts: skew dependence, because a barrier reads the wing of the distribution, and hedge instability at the barrier. Naming the barrier shift shows you have seen how a desk actually handles it.

   Expect next

   • Why is a barrier option so much more skew-sensitive than a vanilla?
   • How do you hedge through the barrier in an illiquid name?
   • Where does barrier risk actually sit in the market, and why does it correlate?
6. 032You are long a one-month at-the-money straddle at 20 volatility. Under what conditions do you make money?The GreeksHardtechnicalVolatility tradingProp trading firms

   Say this

   If you delta hedge it, you make money when realised volatility over the month exceeds 20. If you do not hedge it, you make money only if the stock finishes far enough from the strike to cover the combined premium, which is a much harder bar. Those are two completely different trades and the distinction is the answer.

   Then walk it

   1. Unhedged: you paid, say, 4.6 percent of spot for the straddle, so the stock must move more than 4.6 percent in either direction by expiry. Direction does not matter, distance does — and crucially, the path does not help you at all.
   2. Hedged: you rebalance delta daily and harvest the moves. Now the path is everything. A stock that oscillates 2 percent a day and finishes flat pays you handsomely while the unhedged straddle expires worthless.
   3. The break-even in the hedged case is the realised-versus-implied comparison. Twenty percent annualised is about 1.25 percent a day. If the stock is genuinely moving more than that, gamma harvesting beats the theta you bleed.
   4. Arithmetic to make it concrete: 20 volatility on a 30-day option costs roughly 20 times root of 30 over 365, about 5.7 percent of spot for the straddle at a 0.8 scaling — call it 4.5 to 5 percent. So you need about a 5 percent move unhedged, or sustained daily moves above 1.25 percent hedged.
   5. Two things can still beat you even if you are right about realised volatility. Implied volatility can fall, which hits your vega mark immediately, and the realised moves can arrive as one gap rather than as daily oscillation — a gap gives you the payoff once rather than repeatedly.
   6. The honest limitation: long gamma is not a free option on chaos. You pay theta every day, and in a market that grinds quietly for three weeks and then explodes on day 25, you may have been stopped out of the position before the payoff arrives. Sizing and horizon matter as much as the volatility view.

   Where candidates lose it

   Answering only the unhedged version — 'the stock has to move more than the premium'. Any interviewer on a volatility desk is testing whether you know the hedged straddle is a bet on realised variance and the unhedged one is a bet on the terminal price. Say both, and say which one you meant.

   Expect next

   • What if the stock moves 5 percent but in one overnight gap?
   • You were right about realised volatility and still lost money. How?
   • Would you rather own the straddle or a variance swap for this view?
7. 033What is pin risk, and how do you manage a large position into expiry?The GreeksHardsuperdayMarket makingEquity derivatives

   Say this

   Pin risk is the risk that the underlying closes almost exactly at your strike, so you do not know whether you will be assigned. You go into the weekend not knowing whether you are flat or hugely long or short stock, and by the time you find out, the market has moved. It is a settlement risk, not a pricing risk.

   Then walk it

   1. The mechanism: you are short 1,000 at-the-money calls and the stock settles at the strike. If they are exercised you are short 100,000 shares; if not you are flat. You cannot hedge a position you do not know you have.
   2. Gamma explodes into expiry for at-the-money options, so your delta swings between near zero and near one on tiny price moves. The hedge you put on at 3:29 can be completely wrong at 3:30.
   3. How desks manage it: reduce the at-the-money position before the last hour, close out rather than let it go to assignment, and avoid being short large size at a strike where open interest is concentrated.
   4. Cash settlement solves it. Indian index options — Nifty and Bank Nifty — are cash-settled on a weighted average of the last half hour, so there is no assignment ambiguity. But cash settlement creates a different problem: settlement-price manipulation risk, which is exactly why SEBI moved to a VWAP of the closing period rather than a closing print.
   5. That closing-period mechanic is why you see the volume spike into the last thirty minutes on expiry day in India. Large positions need to hedge against the same average that determines their settlement.
   6. The broader lesson to volunteer: pin risk is one of a family of expiry-day operational risks — assignment, settlement price, and the exercise cut-off being after the market closes so you can be assigned on news that broke post-close. These are the risks that lose money on well-hedged books, and they are the reason expiry-day process discipline exists.

   Where candidates lose it

   Explaining pin risk as a pricing phenomenon. It is an operational and settlement risk, and the answer should include what you do about it — reduce size, close rather than assign, and know whether your contract is cash or physically settled. Naming the Indian cash-settlement mechanic shows local knowledge.

   Expect next

   • How does cash settlement change the problem, and what new problem does it create?
   • Why does volume spike in the last half hour of an Indian expiry day?
   • You are assigned on news that broke after the close. What is your exposure?
8. 050You think the skew is too steep. How do you trade that, and what are you exposed to?Option strategiesHardsuperdayVolatility tradingExotics trading

   Say this

   Sell the risk reversal: sell the out-of-the-money put and buy the out-of-the-money call, in vega-neutral ratio, and delta hedge. That is a direct bet that the put wing is expensive relative to the call wing. What you are exposed to is a crash, because you have sold exactly the insurance that pays off in one.

   Then walk it

   1. Structure: short the 25-delta put, long the 25-delta call, sized so the two vegas offset, then hedge the residual delta with futures. Now you are flat level of volatility and short skew.
   2. Why skew can be too steep: it contains a risk premium as well as a distributional forecast. After a shock the put wing often stays bid for months on hedging demand long after the realised tail risk has faded, which is when the trade has an edge.
   3. The exposures. You are short vanna, so a selloff that lifts volatility hits you twice. You are short the left tail outright, so a genuine crash is a large loss, not a marked one. And you have positive carry in a calm market, which is the seductive part.
   4. This is a classic picking-up-pennies trade, so the sizing rule matters more than the view: define the loss in a minus 20 percent, plus 25 volatility scenario before you put it on, and make that number survivable.
   5. The alternative expression is a put spread instead of an outright short put — sell the 25-delta put and buy the 10-delta. You keep most of the skew edge and cap the tail. You give up some premium and the trade becomes about the slope between two wing strikes rather than the whole wing.
   6. And the honest historical note: skew has been persistently 'too steep' on most measures since 1987, and shorting it has been profitable on average and career-ending in specific years. The trade is a volatility-of-volatility exposure as much as a skew view, and any backtest that does not include 2008, 2018 and 2020 is not telling you about the risk.

   Where candidates lose it

   Proposing a naked short put as the skew trade. The interviewer wants vega-neutral construction, a delta hedge, and an explicit statement of the tail. And you should volunteer the put-spread version, because capping the wing is what makes the trade institutional rather than reckless.

   Expect next

   • How do you make it vega-neutral, and why does that matter?
   • What does vanna do to you in a selloff?
   • Why has skew been persistently steep since 1987?
9. 051Structure a product for a client who wants equity upside with capital protection. What do you build and what are you not telling them?Option strategiesHardcase studyStructured productsWealth management

   Say this

   A zero-coupon bond plus a call option: put most of the money in a bond that matures at par to guarantee the principal, and spend the rest on index calls for the upside. What I would not hide is that the participation rate is set by how much premium the bond leaves over, that you forgo dividends, and that the protection is only as good as the issuer's credit.

   Then walk it

   1. The build on 100 rupees with a five-year horizon and rates at 7 percent: a zero-coupon bond maturing at 100 costs about 71. That leaves 29, less the dealer's margin, to buy five-year at-the-money index calls.
   2. If those calls cost 20, the participation rate is about 130 percent of the index move; if implied volatility is high and they cost 35, you cannot even get to 100 percent participation, and the structure has to be cheapened with a cap or a knock-out.
   3. So participation is a residual, not a feature. High rates make protection cheap and structures generous; low rates and high volatility make them mean. That is the single most useful thing to explain to a client who is comparing two notes.
   4. The things a sales deck buries: you receive no dividends over five years, which on an equity index is a substantial forgone return; the capital protection is an issuer obligation, not a segregated guarantee, which is what made 2008 Lehman notes worthless; and secondary liquidity is at the dealer's bid.
   5. The cheapening devices to watch for are where the real risk is: a knock-in put that turns protection into leveraged downside, an autocall that ends the trade just as it starts working, or a worst-of basket that sounds diversified and is actually short correlation.
   6. The comparison I would give honestly: for a client who can tolerate the volatility, a bond and equity blend replicates most of this at a fraction of the fee. The structure earns its keep when the client genuinely cannot bear a nominal loss, or has a regulatory or accounting reason to need a floor. Otherwise it is a well-packaged way of paying for behaviour.

   Where candidates lose it

   Building the bond-plus-call structure and presenting the participation rate as a design choice. It is arithmetic — it falls out of rates, volatility and fees. And you must name the issuer credit risk and the forgone dividends, because that is the disclosure test the interviewer is actually running.

   Expect next

   • What happens to the participation rate if rates fall to zero?
   • Where is the client short correlation in a worst-of basket?
   • Would a simple 70-30 portfolio do better, and when would it not?
10. 062What section of the indenture deals with payment waterfalls, and how does cash actually move through a structured credit deal?Credit derivativesHardsuperdayNomuraStructured Products · New York · 2026

    Say this

    The priority of payments section of the indenture, usually Article 11 in a CLO indenture, with the interest and principal waterfalls set out separately. Cash from the loan portfolio is collected in interest and principal accounts and then paid out strictly in seniority order, subject to coverage tests that can divert cash upward if the deal is underperforming.

    Then walk it

    1. Two waterfalls, kept separate by design. Interest proceeds pay fees, then senior note interest, then down the stack. Principal proceeds are used during reinvestment to buy more loans, and after that to amortise notes top-down.
    2. The accounts matter and this is what the operational question is really about: a collection account split into interest and principal, an unfunded amounts or ramp-up account at new issue, an expense reserve, and often an interest reserve for the first payment date before the portfolio is fully ramped.
    3. The tests are the teeth. Overcollateralisation and interest coverage tests are measured at each payment date, and a failure diverts cash that would have gone to the junior tranches into paying down the senior notes until the test is cured. That is the structural protection the AAA buyer is paying for.
    4. There is usually also a reinvestment overcollateralisation test which, if failed, sends a portion of equity distributions to buy more collateral rather than pay the equity — a softer version of the same mechanism.
    5. At new issue settlement the account structure is what trips people up: the ramp-up account holds undrawn proceeds, loans settle over weeks with delayed compensation, and the first payment date often needs an interest reserve because the portfolio has not been earning for a full period.
    6. The honest framing: the waterfall is the product. Credit analysis of the underlying loans matters, but the reason the AAA has performed through two cycles is the diversion mechanics, and the reason equity returns are volatile is that it sits last in both waterfalls and absorbs every test failure first.

    Where candidates lose it

    Waving at 'senior gets paid first'. This question is asked to find out whether you have read a document. Name the priority of payments section, name the interest and principal waterfalls separately, and name the overcollateralisation test diversion — that is the mechanic that defines the product.

    Expect next

    • What happens to equity distributions when the overcollateralisation test fails?
    • Which accounts exist at a new issue settlement and why?
    • Why has the CLO AAA performed so well through credit cycles?

    Reported by candidates at Nomura (Structured Products, New York, 2026). Source: Wall Street Oasis.

Firm tags come from public, anonymous candidate reports on Wall Street Oasis: strong signal, not sworn testimony. Firms are named as the places a question was reported, not as partners of Fin Maverick. Answers are written for this page to show how to think out loud; they are not scripts to recite.