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. 042If you want pure exposure to volatility, why use a variance swap rather than a straddle?VolatilityHardsuperdayVolatility tradingHedge funds

   Say this

   Because a straddle's exposure to volatility changes as spot moves away from the strike, and a variance swap's does not. The variance swap pays realised variance minus a fixed strike, with constant exposure regardless of where spot goes. It is the clean instrument; the straddle is a path-dependent approximation to it.

   Then walk it

   1. The straddle problem: gamma and vega are concentrated at the strike. Spot moves 10 percent and your straddle is now a directional position with little volatility exposure left, so you have to keep re-striking to maintain the view.
   2. A variance swap pays the notional times realised variance less the strike variance. No re-striking, no delta to manage in the same way, and the payoff is linear in variance by construction.
   3. How it exists at all: you can replicate it statically with a portfolio of options across all strikes weighted by one over strike squared, plus a dynamic futures hedge. That replication is why it can be quoted without a model.
   4. The catch, and it is a big one: variance is the square of volatility, so the payoff is convex in volatility. A short variance position loses quadratically. At a 20 strike, realised of 60 is nine times the variance, not three times — which is how short variance books were destroyed in 2008.
   5. Which is why the market largely moved to capped variance swaps after 2008, typically capped at 2.5 times the strike. A volatility swap — linear in volatility rather than variance — is the other answer, but it needs a model to price because it is not statically replicable.
   6. And one practical limitation: the replication needs a continuum of strikes. In reality you have a finite strike grid, so a genuine jump produces a payoff the replicating portfolio did not deliver. Single-stock variance swaps on names with takeover risk are notorious for this, which is why dealers price them wide or refuse them.

   Where candidates lose it

   Saying 'variance swaps give pure volatility exposure' without naming the convexity. Variance is the square, so short positions lose non-linearly, and the 2008 blowups plus the move to capped structures are the evidence. That detail is what makes the answer sound like it came from a desk.

   Expect next

   • So why did the market start capping them?
   • What is the difference between a variance swap and a volatility swap?
   • Why are single-stock variance swaps dangerous for a dealer?
2. 043Explain a covered call. When is it the right trade and what is the real risk?Option strategiesCorephone / first roundWealth managementIndian broking

   Say this

   Long the stock, short a call against it. You collect premium and cap your upside at the strike. It is the right trade when you are mildly bullish to neutral and would be happy to sell at the strike. The real risk is not the stock falling — it is that you have sold the upside tail, which is where most of an equity's long-run return lives.

   Then walk it

   1. Payoff: you keep the premium plus any appreciation up to the strike, and above that you deliver the stock. Below, you take the full downside less the premium you received.
   2. So it is the same payoff shape as a short put at that strike — the synthetic equivalence falls straight out of put-call parity. Anyone selling covered calls should know they are running a short-put risk profile.
   3. When it works: a range-bound stock, a high implied volatility that you think is overpriced, or a genuine intention to exit at the strike. Overwriting is also a legitimate income overlay for a mandate that has to generate yield.
   4. The honest risk: your worst outcome is being right about direction and wrong about magnitude. The stock triples, you delivered at plus 10 percent, and you have converted an asymmetric long-run payoff into a capped one. Equity index returns are driven by a small number of very large up moves, so capping them is expensive.
   5. There is also a tax and path problem in practice: getting called away triggers a realisation you may not have wanted, and rolling the short call up in a rally locks in a loss on the option leg while the stock leg is unrealised.
   6. Where I would actually use it: on a position I already intended to trim, at a strike that equals my target exit price, with the premium as a sweetener. Framing it as income on a core holding you want to keep forever is the mis-sale, and it is a very common one in retail advisory.

   Where candidates lose it

   Selling it as free income. The interviewer will ask what happens in a 40 percent rally, and the answer that gets respect is that a covered call is a short put in disguise and you have sold the fat right tail. Say the synthetic equivalence out loud.

   Expect next

   • What position is a covered call equivalent to?
   • The stock rallies 50 percent. What do you do?
   • Would you recommend a covered call programme to a long-term retirement portfolio?
3. 045Straddle or strangle — how do you choose?Option strategiesIntermediatetechnicalProp trading firmsVolatility trading

   Say this

   Both are pure volatility positions with no directional view. A straddle buys the at-the-money call and put, so you pay more and get maximum gamma right where spot is. A strangle buys out-of-the-money strikes, so it costs less and needs a bigger move, but it gives you more exposure to the tails per rupee spent.

   Then walk it

   1. Straddle: highest gamma and vega concentrated at the strike, highest premium, highest theta bleed. You want it when you expect a move and you expect it soon, and when you will delta hedge to harvest the path.
   2. Strangle: cheaper, wider break-evens, lower theta per day. You want it when you expect a large move but are unsure of timing, or when you specifically believe the wings are underpriced relative to the body.
   3. The wings-versus-body choice is a skew and kurtosis view, not just a cost decision. Long strangle, short straddle is a butterfly — that is a pure bet that the distribution is fatter-tailed than the smile implies.
   4. Break-even arithmetic: a 4.5 percent straddle needs a 4.5 percent move by expiry. A strangle costing 2 percent with strikes 5 percent out needs a 7 percent move. So the strangle wins only in the big-move scenarios and loses in the moderate ones.
   5. In practice the choice is often dictated by liquidity and margin. In Indian index options the out-of-the-money weekly strikes are extremely liquid and cheap in absolute rupee terms, which is why retail gravitates to strangles — and why the margin framework treats short strangles more punitively after the 2020 peak-margin reforms.
   6. The limitation for both: if you are not delta hedging, you are betting on the terminal price, not on volatility, and a stock that swings wildly and closes flat pays you nothing. State which trade you are actually putting on.

   Where candidates lose it

   Framing it purely as 'strangle is cheaper'. The real distinction is where you want your gamma and whether your view is about the body or the tails of the distribution. And name the unhedged-versus-hedged difference, because otherwise you are describing a direction bet.

   Expect next

   • Long strangle against short straddle — what have you built and what is the view?
   • Which would you rather own into an earnings print?
   • What does margin treatment do to the choice in India?
4. 047Why would you buy a call spread instead of just buying a call?Option strategiesCoretechnicalIndian brokingWealth management

   Say this

   Because you have a target, not an unbounded view. Selling the higher strike funds a chunk of the premium, cuts your theta and vega, and raises your probability of profit — at the cost of capping the payoff. If your thesis is 'up 8 percent by June' rather than 'up a lot', the spread is the honest expression of it.

   Then walk it

   1. Mechanics: buy the 100 call for 5, sell the 110 call for 2, net cost 3, maximum payoff 10 at or above 110. You have turned a 5-point bleed into a 3-point bleed and a 7-point maximum gain.
   2. The Greeks get tamer. Vega and theta both shrink because you are long one option and short another, so a fall in implied volatility hurts far less. If you are worried about buying expensive volatility, the spread protects you against that.
   3. Probability of profit rises because the break-even is nearer. You need the stock at 103 rather than 105, which on a one-month view is a meaningful difference.
   4. It is also a skew trade whether you intend it or not. In an equity index the calls you sell are cheaper in implied terms than the calls you buy, so a call spread is a mildly unattractive skew position. Put spreads in equities work the other way — you sell the expensive wing.
   5. Where it goes wrong: the payoff is capped, so a takeover or a squeeze that takes the stock to 150 pays you the same 7 as a move to 110. If your thesis has a fat-tail scenario in it, the spread is the wrong structure.
   6. And near expiry a spread can be awkward to close — you may have to trade out of two legs in thin markets, or face assignment on one leg and not the other. The neat payoff diagram assumes you hold to expiry, and in practice the exit cost is real.

   Where candidates lose it

   Just saying it is cheaper. Cheaper is not a reason on its own — you paid less and you get less. The answer is about matching the structure to the shape of your view, plus the reduction in vega if you think implied volatility is high. Mention the skew direction to sound like a trader.

   Expect next

   • How does the skew affect a call spread versus a put spread in equities?
   • What if the stock gets taken over at a 50 percent premium?
   • Which leg would you close first if you wanted out early?
5. 048Explain a butterfly and an iron condor, and tell me what view each expresses.Option strategiesIntermediatetechnicalProp trading firmsVolatility trading

   Say this

   Both are short-volatility, range-bound structures with capped losses. A butterfly is short the body and long the wings — sell two at-the-money options, buy one either side. An iron condor is the same idea with a gap in the middle: sell an out-of-the-money put and call, buy further-out ones as protection. The view is that the underlying stays in a range and that implied volatility is too high.

   Then walk it

   1. Butterfly payoff: maximum profit if the underlying pins the middle strike at expiry, losses limited to the width less the credit. It has the highest payoff concentration of any standard structure, which is why it is the expiry-day trade of choice.
   2. Iron condor: a wider profit plateau between the two short strikes, smaller maximum profit, higher probability of ending inside the range. It is the same trade with less precision required about where the underlying lands.
   3. Read a long butterfly as short kurtosis. You are selling the body and buying the wings, which is a statement that the distribution is thinner-tailed than the smile implies. That is why butterfly prices are how FX desks quote the curvature of the smile.
   4. Both are short gamma and short vega in the middle, so they make money from time passing and from implied volatility falling. Both have their worst outcome on a large move in either direction, which is bounded by the long wings.
   5. Where they actually get used in India: Nifty and Bank Nifty weekly expiries, because the short-dated theta is large and the structures are margin-efficient once the wings are in place. That is also where they are most frequently oversized by retail traders.
   6. The real risk is the one the payoff diagram hides: the position is fine at expiry and can be badly underwater before it. A move to the edge of the range mid-life produces a mark-to-market loss and a margin call, and traders get closed out of positions that would have been profitable if held. Capped loss is not the same as capped margin.

   Where candidates lose it

   Drawing the payoff diagram and stopping. Two things earn the answer: naming the butterfly as a curvature or kurtosis trade, and pointing out that a capped-loss structure can still force you out early through margin. That second point is where retail traders in weekly options actually lose.

   Expect next

   • Why do FX desks quote the smile using butterflies?
   • Which is safer for a retail trader, and does the margin agree with you?
   • What happens to your iron condor two weeks in with spot at the short put strike?
6. 049What is a calendar spread and what are you really trading?Option strategiesIntermediatetechnicalVolatility tradingMarket making

   Say this

   Same strike, two expiries. Long the back month and short the front is a long calendar: you are long vega, short gamma, and long the term structure. What you are really trading is the slope of the volatility curve plus the difference between short-dated and long-dated realised volatility.

   Then walk it

   1. Positioning: the front month has most of the gamma and theta, the back month most of the vega. So long the back and short the front collects theta from the front and stays long vega on the back.
   2. The classic use is after a volatility spike. The front month is at 60, the back at 30, so you sell the front and buy the back, betting on mean reversion in the near term rather than on the level of volatility.
   3. It is also an event trade in reverse. If an earnings date sits in the front expiry, the front implied is inflated by the event. Selling the front and buying the back captures the event premium if the print is quiet.
   4. Risks are asymmetric and this is the part to get right. Short front-month gamma means a large move immediately is very painful, because the front option's gamma dwarfs the back's. The position is long volatility in vega terms and short it in gamma terms, and those two can lose at the same time.
   5. Roll and pin risk at the front expiry are real operational issues. You have to manage the front leg through settlement, and if it finishes at the strike you have a pin problem on one leg of a position you intended to hold.
   6. The honest limitation: a calendar spread is a term-structure view, so you can be exactly right about the volatility level and lose because the curve moved in parallel rather than flattening. Calendars are best sized small and judged on the spread between the two implieds, not on either leg alone.

   Where candidates lose it

   Describing a calendar as 'selling time decay'. It is a term-structure trade with opposite signs on gamma and vega, and the danger is an immediate large move against short front-month gamma. Naming the post-spike mean-reversion use case shows you know why anyone puts it on.

   Expect next

   • Which leg holds your gamma and which your vega?
   • What happens if the market gaps the day after you put it on?
   • How would you use a calendar around an earnings date?
7. 052What is an interest rate swap, and why would a company enter one?Swaps and ratesCorephone / first roundRates derivativesCorporate treasury

   Say this

   Two parties exchange interest payments on a notional that never changes hands — typically one pays fixed and receives floating, the other the reverse. Companies use them to change the interest rate character of debt they have already issued, without refinancing it.

   Then walk it

   1. Mechanics: on a five-year, 100 million rupee notional swap, one side pays a fixed rate semi-annually and receives the floating benchmark reset each period. Only the net difference settles, so the cash flows are small relative to the notional.
   2. The classic corporate use: a company issues a floating-rate loan because that is what the bank offered, then pays fixed on a swap to convert it into synthetic fixed-rate debt. It has locked its interest cost without renegotiating the loan.
   3. The reverse is just as common. A company with a fixed-rate bond that wants floating exposure — perhaps because its revenues are rate-sensitive — receives fixed on a swap. This is asset-liability matching, and for a bank it is the core of managing the gap between deposits and loans.
   4. There is also a comparative advantage story, which is where swaps came from: two borrowers each have better access to a different market, so they each borrow where they are cheap and swap the payments. The gain is split between them.
   5. Pricing: at inception the swap has zero value, because the fixed rate is set so the present value of the fixed leg equals that of the floating leg. It then acquires value as rates move, which is how it becomes a live mark-to-market and margin exposure.
   6. The risks to name: rate risk obviously, but also that a hedge which is economically right creates accounting volatility unless you qualify for hedge accounting, and that collateral calls under the CSA can be substantial even when the hedge is doing its job. Treasurers who did not model the collateral drain have been caught out by that more than by the rate move.

   Where candidates lose it

   Describing the exchange of cash flows without saying why a company would bother. The answer is about converting the character of existing debt without refinancing. And notional is not exchanged in a plain vanilla rate swap — saying otherwise gets you marked down instantly.

   Expect next

   • Is the notional exchanged?
   • What is the swap worth on day one, and why?
   • How does a bank use swaps to manage its deposit book?
8. 053How do you price an interest rate swap?Swaps and ratesIntermediatetechnicalRates derivativesQuant trading

   Say this

   Value each leg as a bond and take the difference. The fixed leg is a set of known cash flows discounted on the curve; the floating leg is worth par at each reset, so it discounts to a simple expression. The swap rate is the fixed rate that makes the two legs equal, so the swap is worth zero at inception.

   Then walk it

   1. Fixed leg: sum the fixed coupons, each discounted by the appropriate discount factor. That is just a bond price without the principal.
   2. Floating leg: the elegant result is that a floating-rate note resets to par at every coupon date, so the whole floating leg is worth notional times the difference between two discount factors. Alternatively, project each forward rate off the curve and discount it — same answer.
   3. Set them equal and solve for the fixed rate. The swap rate is a weighted average of the forward rates over the life, with the discount factors as weights.
   4. Post-2008 the important refinement is that you use two curves, not one. You project the floating rate off the relevant forward curve — SOFR or MIBOR — and you discount on the curve that matches the collateral you actually post, which for a cleared swap is the overnight rate. That is OIS discounting, and it materially changed swap valuations in 2009 to 2010.
   5. Why that matters: before the crisis everyone discounted at LIBOR and assumed one curve served both purposes. The crisis blew out the basis between overnight and term rates, revealing that discounting must reflect the funding cost of the collateral, not the index on the floating leg.
   6. Then the valuation adjustments for an uncollateralised swap: CVA for the counterparty's default risk, FVA for the cost of funding an unhedged position, and for the dealer, capital charges. A swap with a corporate that posts no collateral prices meaningfully away from the cleared mid, and that gap is a real charge, not a spread grab.

   Where candidates lose it

   Giving the single-curve textbook answer. Any rates interviewer will follow up on OIS discounting and the multi-curve framework, because that is the actual market practice since 2010. Also be ready to say why a floating leg is worth par at reset — the argument, not the formula.

   Expect next

   • Why do you discount on a different curve from the one you project on?
   • Why is the floating leg worth par at each reset?
   • How would the price change for an uncollateralised corporate counterparty?
9. 054How does duration affect interest rate risk?Swaps and ratesIntermediatetechnicalPIMCODebt Capital Markets · San Diego · 2026

   Say this

   Duration is the sensitivity of a bond's price to a change in yield, in years. A duration of 7 means a 100 basis point rise in yields costs you roughly 7 percent of value. So duration is not a description of the bond's maturity — it is the size of your interest rate exposure, and it is what you hedge.

   Then walk it

   1. Macaulay duration is the weighted average time to receipt of the cash flows. Modified duration divides that by one plus the yield, and it is the number you use for price sensitivity.
   2. The working formula: percentage price change is approximately minus modified duration times the yield change. Add convexity for large moves — plus a half times convexity times the yield change squared — because the price-yield relationship is curved, not linear.
   3. Convexity is your friend as a bondholder: it means you lose less on a rate rise than duration alone predicts and gain more on a fall. Which is also why convexity costs something in the price.
   4. The drivers: longer maturity, lower coupon and lower yield all raise duration. A zero-coupon bond's duration equals its maturity, which is the cleanest case and the reason zeros are the sharpest rate instrument.
   5. How it gets used: dollar duration, meaning duration times market value, is what you actually hedge. If a 500 million portfolio has duration 7, its dollar duration is 35 million per 100 basis points, and you short enough bond futures or pay fixed on enough swap notional to offset it.
   6. The limitation to volunteer: duration assumes a parallel shift in the curve. Real curves steepen, flatten and twist, so a duration-matched portfolio can still lose money on a curve move. That is why desks look at key rate durations bucketed along the curve rather than one number. And for callable or mortgage-backed bonds, duration itself changes with yields — negative convexity — so the static number misleads exactly when you need it.

   Where candidates lose it

   Defining duration as average time to cash flows and stopping. The question asks about risk, so lead with the sensitivity reading and the dollar duration hedge. And name the parallel-shift assumption — a bond manager will expect key rate durations to come up.

   Expect next

   • What does convexity add?
   • How would you hedge the duration of a 500 million portfolio?
   • Where does duration break down as a risk measure?

   Reported by candidates at PIMCO (Debt Capital Markets, San Diego, 2026). Source: Wall Street Oasis.

10. 055What is effective duration, and when would you use it instead of modified duration?Swaps and ratesIntermediatetechnicalAmundiRates · London · 2018

    Say this

    Effective duration is measured rather than derived: you shock the whole yield curve up and down by a small amount, reprice the bond with its options and cash flow rules intact, and read the sensitivity off the two prices. You use it whenever the cash flows themselves depend on rates — callables, putables, mortgages, floaters — because modified duration assumes they do not.

    Then walk it

    1. Formula: price down minus price up, divided by twice the initial price times the size of the shock. It is a numerical derivative, which is the whole point — you are not assuming a closed form.
    2. Modified duration is computed from fixed, known cash flows. The moment a bond is callable, the issuer's option changes the cash flows as rates move, so the analytical number is simply wrong.
    3. Callable bonds are the classic case. Rates fall, the call becomes likely, the expected life shortens, and duration falls — so the bond's price rise is capped. That is negative convexity, and effective duration captures it while modified duration cannot.
    4. Mortgage-backed securities are the extreme version, because prepayment behaviour is the option. Effective duration on an MBS moves sharply with rates, which is why convexity hedging by mortgage portfolios amplifies rate moves in the Treasury market.
    5. It is also the right measure for a floating-rate note, where the coupon resets. A floater has a long maturity and an effective duration of months, because its price barely responds to a level shift in rates.
    6. The caveat worth adding: effective duration is model-dependent, since repricing a callable requires an assumption about volatility and about how the issuer exercises. Two houses will produce different effective durations for the same bond, and the difference is a model choice rather than a data error. And the parallel-shift assumption is still in there — key rate durations are how you get past it.

    Where candidates lose it

    Treating effective and modified duration as synonyms, or defining effective duration with a formula but no reason to prefer it. Name a bond with embedded optionality — callable or mortgage — and say that its cash flows move with rates. That is the whole distinction.

    Expect next

    • What is the effective duration of a floating-rate note?
    • Why does a callable bond have negative convexity?
    • How does MBS convexity hedging move the Treasury market?

    Reported by candidates at Amundi (Rates, London, 2018). 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.