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. 041What is the VIX, and how is it actually computed?VolatilityIntermediatetechnicalVolatility tradingIndian derivatives desks

   Say this

   It is the market's 30-day expected volatility on the S&P 500, expressed annualised in percentage points. It is not an average of implied volatilities — it is built from a strip of out-of-the-money option prices across all strikes, which makes it a model-free estimate of the square root of expected variance.

   Then walk it

   1. The construction: take all reasonably liquid out-of-the-money puts and calls in the two expiries that straddle 30 days, weight each by one over its strike squared, sum, interpolate to exactly 30 days, take the square root and annualise.
   2. The one-over-strike-squared weighting is the part worth knowing. It comes from the mathematics of replicating a variance swap: a portfolio of options weighted that way has a payoff equal to realised variance. So the VIX is the fair strike of a 30-day variance swap, quoted as a volatility.
   3. That is why it is called model-free. It does not use Black-Scholes at all — it reads variance straight off prices. The older VIX methodology up to 2003 did use at-the-money Black-Scholes implieds, and the change matters when you compare long histories.
   4. Because it uses every strike, it is sensitive to the wings. A bid in deep out-of-the-money puts lifts the VIX even if at-the-money implied volatility has not moved, which is why the VIX can rise on a flat day.
   5. You cannot trade the index. You trade VIX futures and options, and the futures are priced off forward variance rather than spot VIX, so they do not track it one for one. In a spike, the front future will lag spot VIX substantially.
   6. India's equivalent is the India VIX, built on Nifty options with the same methodology adapted by the NSE. It matters for the same reason: it is the reference for weekly-expiry positioning and it inverts in exactly the same way in a stress event.

   Where candidates lose it

   Calling it 'an average of option implied volatilities'. It is a variance-swap strike, and the one-over-K-squared weighting is the specific thing the interviewer is checking. Also expect the follow-up on why VIX futures do not track spot VIX — have the forward-variance answer ready.

   Expect next

   • Why doesn't a VIX future track spot VIX?
   • Why can VIX rise on a day when at-the-money implied is unchanged?
   • What is India VIX built on?
2. 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?
3. 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?
4. 044A client holds a large concentrated equity position and wants protection but hates paying premium. What do you show them?Option strategiesIntermediatetechnicalWealth managementEquity derivatives

   Say this

   A zero-cost collar: buy a put, fund it by selling a call, struck so the premiums net to zero. It gives them a floor without a cash outlay, and the price is giving up the upside above the call strike. If they will not accept an upside cap, the honest answer is that protection costs money and there is no way around it.

   Then walk it

   1. Structure it concretely: stock at 100, buy the 90 put, sell the 112 call, and the two premiums roughly offset. They are now locked into a band between 90 and 112 with no premium paid.
   2. The asymmetry in the strikes is the skew at work. Puts are more expensive than equidistant calls, so to fund a 10 percent-out put you have to sell a call closer than 10 percent out. Explaining that asymmetry to the client is part of the job.
   3. Alternatives worth showing: a put spread, which is cheaper than an outright put and still leaves upside open but only protects a band; or a longer-dated put, which costs more in absolute terms but far less per month of protection because vega scales with root time.
   4. For a genuinely concentrated founder position, there are also prepaid variable forwards and exchange funds, which address the concentration rather than just the price risk. Those have tax and lock-up consequences that usually dominate the pricing question.
   5. Constraints to raise before the structure: is the client an insider, does the position have a lock-up or pledge, and what does the collar do to their tax position. In several jurisdictions a tight collar can be treated as a constructive sale, which triggers the tax event they were trying to defer. That is the reason the call strike is often set wider than the pricing alone would suggest.
   6. And the behavioural risk: a collar that caps upside at 112 will feel like a mistake if the stock goes to 160, and the client will remember whose idea it was. So I would document the trade-off in their own words, and size the collar over part of the position rather than all of it.

   Where candidates lose it

   Presenting the zero-cost collar as free. It is not free, it is paid for with the upside, and the skew means the upside you give up is closer than the downside you protect. Also raise the tax and constructive-sale issue — that is the difference between a textbook answer and advice.

   Expect next

   • Why is the call strike closer than the put strike?
   • What are the tax consequences of a tight collar?
   • What would you do instead if the client refuses any upside cap?
5. 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?
6. 046If you think the market is overestimating volatility, what options strategy can you use?Option strategiesIntermediatetechnicalOld Mission CapitalProp Trading · Chicago · 2025

   Say this

   Sell a delta-hedged straddle, or sell a variance swap if one is available. The view is that implied volatility is above what will be realised, so you want to be short implied and long nothing directional — which means selling options and hedging the delta as you go, not just selling a strangle and hoping.

   Then walk it

   1. Cleanest expression: short at-the-money straddle, delta hedged continuously. You collect the premium and pay away the realised variance, so if realised comes in below the implied you sold, the difference is your profit.
   2. Even cleaner if the market exists: short a variance swap. The payoff is exactly the strike variance minus realised, with no re-striking and no path dependence in the exposure.
   3. If the view is specifically that implied volatility itself will fall rather than that realised will be low, sell longer-dated options where vega dominates, or sell VIX futures or calls. Those are different trades — one is a realised-volatility view, the other a mark-to-market view on the surface.
   4. Then the risk management, which is really what the question is testing. Naked short volatility has unbounded loss and negative convexity, so the professional version is an iron condor or a short straddle with wings bought — you cap the tail, give up some premium, and survive the event that proves you wrong.
   5. Sizing rule I would say out loud: size to the loss in a plausible tail, not to the premium collected. If a 5 standard deviation move ends the account, the position is too big whatever the expected value says.
   6. And the honest caveat: implied above realised is the normal state, so being short volatility is a bet that the premium is bigger than usual, not that it exists. You need a reason — a specific event that has passed, a supply imbalance, a spike that has already resolved — rather than a general sense that options are expensive.

   Where candidates lose it

   Answering 'sell a straddle' and stopping. A prop shop is testing whether you delta hedge, whether you cap the tail, and whether you can distinguish a realised-volatility view from a view on implied. Volunteer the sizing rule before they ask what happens in a crash.

   Expect next

   • How do you cap the tail, and what does it cost you?
   • Is your view about realised volatility or about implied volatility falling?
   • How would you size it?

   Reported by candidates at Old Mission Capital (Prop Trading, Chicago, 2025). Source: Wall Street Oasis.

7. 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?
8. 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?
9. 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?
10. 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?

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.