Long and Short Positions Practice Questions for the SIE

Answer: The maximum potential loss is $6,000, the amount invested

A long stockholder's worst case is that the stock becomes worthless, so the loss is capped at the $6,000 invested (100 × $60), while the potential gain is unlimited because there is no ceiling on a stock's price. Choice A swaps the risk profiles: unlimited loss belongs to the short seller, who must eventually buy back shares at whatever price the market demands. Choice B applies the short seller's capped-gain math (gain limited to sale proceeds) to an owner. Choice D reverses the sentiment — long means bullish, profiting on a rise. Drill the 2×2 risk grid until automatic: long stock = max loss is the investment, max gain unlimited; short stock = max gain is the proceeds, max loss unlimited.

The Trap: long position assigned unlimited loss / short risk profile

• The position profits if RST's price declines: Misconception: sentiment flip — a long position is bullish and profits when the price rises; profiting from a decline describes a short position.
• The maximum potential loss is unlimited: Misconception: swaps the long and short risk profiles — unlimited loss belongs to the short seller, not the owner; a stock cannot fall below zero.
• The maximum potential gain is $6,000: Misconception: applies the short seller's capped-gain logic (gain limited to sale proceeds) to a long position, whose upside is unlimited.

Verified against: FINRA SIE Content Outline §3.1

Answer: Selling borrowed shares with the intention of buying them back later at a lower price

A short sale means selling shares the investor does not own: the broker-dealer borrows the shares for delivery, and the investor profits by repurchasing (covering) later at a lower price — the usual buy-low/sell-high math, executed in reverse order. Choice A describes an ordinary long sale; selling stock you already own just closes a long position. Choice C describes day trading, which involves no borrowed shares. Choice D confuses the word 'sell' with a bearish outlook — a written put is a bullish/neutral position that profits when the stock stays at or above the strike. Note also that under SEC Regulation SHO the firm must locate borrowable shares before executing a short sale, and the trade must take place in a margin account.

The Trap: short sale confused with selling shares you own

• Buying shares and selling them the same day to capture a quick gain: Misconception: confuses day trading a long position with short selling — no borrowed shares are involved and the order of buy/sell is reversed.
• Selling a put option on a stock the investor expects to decline: Misconception: 'anything sold is bearish' — a short (written) put is actually a bullish/neutral position that profits when the stock stays at or above the strike.
• Selling shares the investor already owns and delivering them at settlement: Misconception: 'short selling = selling stock you own' — that is an ordinary long sale, which simply closes a long position.

Verified against: SEC Regulation SHO

Answer: Selling borrowed GHI shares now and buying them back after the decline

Selling borrowed shares now and repurchasing them at a lower price after the decline is the definition of a short sale — the standard bearish stock position, and the only choice here that pays off when the price drops. Two short-sale facts the exam leans on: short sales must be done in a margin account (never a cash account), and because a stock's price has no ceiling, the potential loss on a short is unlimited. Choice B only closes an existing long: it sidesteps further loss, but once the shares are sold the investor has no position and earns nothing from the decline. Choice C is bullish/neutral, not bearish — a put writer keeps the full premium when the stock stays at or above the strike, and a sharp decline puts the option in the money, exposing the writer to assignment and a purchase above market. Choice D is also bullish; margin adds leverage, which magnifies both the gain and the loss, but it does not reverse the direction of the bet. Pair every scenario with its sentiment word: 'expects a sharp decline' points to short stock, long puts, or short calls.

The Trap: selling owned shares treated as profiting from a decline

• Buying GHI shares on margin: Misconception: leverage confusion. Buying on margin is still a long (bullish) bet; borrowing magnifies both the gain and the loss but does not reverse the direction of the bet. This position loses — faster than an unleveraged long — if the stock falls.
• Selling GHI shares the investor already owns: Misconception: closing a long is not shorting. Selling owned shares avoids further loss, but it leaves the investor with no position at all — so nothing is earned as the stock continues to fall.
• Writing (selling) GHI put options: Misconception: 'bearish = short put.' A put writer is actually bullish/neutral — the writer keeps the full premium only if the stock stays at or above the strike. A sharp decline drives the put in the money and the writer can be assigned, forced to buy the stock at the strike price well above market.

Verified against: FINRA SIE Content Outline §3.1 (taxonomy 3.1.1 — long/short, bullish/bearish)

Answer: Buy 500 shares of MNO and return them to the lender

Covering a short means buying the shares in the open market and returning them to the lender — that extinguishes the borrow and closes the position. Choice A confuses covering a short with closing a long: selling shares held elsewhere is a separate long sale that leaves the borrowed shares outstanding. Choice B fails because the short seller owes stock, not cash — the sale proceeds (plus required margin) merely collateralize the stock loan while it remains open. Choice C misreads option sentiment: writing (selling) a put is a bullish income strategy, not a closing transaction, and it does nothing to return the borrowed shares. Keep the vocabulary pair straight: 'covering' closes a short (buy the borrowed shares back), while 'closing a long' means simply selling shares you already own.

The Trap: covering a short confused with closing a long or paying cash

• Sell 500 shares of MNO held long in another account: Misconception: confuses covering a short with closing a long — selling owned shares elsewhere is a separate long sale and leaves the borrowed shares outstanding.
• Sell MNO put options to offset the short stock position: Misconception: treats writing puts as a closing/bearish action — a short put is a bullish position and does not return the borrowed shares or close the stock position.
• Instruct the firm to release the short-sale proceeds to the stock lender: Misconception: the obligation is to return shares, not cash — proceeds and margin merely collateralize the stock loan while it is open.

Verified against: FINRA SIE Content Outline §3.1

Answer: Short 100 shares of common stock

A short stock position carries theoretically unlimited loss: the short seller must eventually buy the shares back to return them to the lender, and there is no ceiling on how high the price can climb before that happens. The SEC states it directly — shorting a stock exposes an investor to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely. Long stock (choice A) is the contrast: risk is limited to the amount invested, because a stock cannot fall below zero. Long options (choices B and D) can lose no more than the premium paid. A common trap is assuming a long call carries unlimited risk because a call offers unlimited upside — the upside is unlimited, but the buyer's risk is still only the premium. Watch the mirror-image trap too: a long put is bearish like a short sale, yet its loss is capped, so 'bearish' does not mean 'unlimited.' The classic unlimited-risk positions tested on the SIE are short stock and uncovered (naked) short calls — both can be forced to buy at any price. This open-ended exposure is a key reason a short sale must be established in a margin account rather than a cash account, with collateral posted beyond the sale proceeds under Regulation T.

The Trap: long call mistaken for an unlimited-risk position

• Long 1 equity put option: Misconception: assumes a bearish option position mirrors short-stock risk — a put buyer's loss is capped at the premium paid.
• Long 1 equity call option: Misconception: students link calls to 'unlimited' because a call offers unlimited upside, but the buyer's loss is capped at the premium paid — unlimited gain, limited loss.
• Long 100 shares of common stock: Misconception: long stock cannot lose more than the amount invested — the stock cannot fall below zero.

Verified against: SEC Investor Bulletin: An Introduction to Short Sales (investor.gov); Regulation T, 12 CFR 220.12(c) (short-sale margin held in a margin account)

Answer: Maximum gain $7,000; maximum loss unlimited

Short-sale profit is capped: the best case is the stock falling all the way to zero, letting the investor keep the entire $7,000 of sale proceeds (200 × $35). The worst case is uncapped, because there is no limit on how high the repurchase price can climb. Choice B assigns the long investor's profile (limited loss, unlimited gain) to a short — an exact inversion. Choice C reflects the common belief that a short seller can lose only the size of the trade; that cap applies to long purchases, not shorts. Choice D gets the loss right but the gain wrong — a stock cannot trade below zero, so the gain is limited to the proceeds. Remember the pairing: short stock = max gain equals proceeds, max loss unlimited.

The Trap: short seller's maximum loss capped at trade size

• Maximum gain $7,000; maximum loss $7,000: Misconception: 'a short seller can only lose the size of the trade' — false. A $7,000 loss cap belongs to a long purchase, where the stock can fall no further than zero. A short is the mirror image: the buy-back price has no ceiling, so the loss is unlimited.
• Maximum gain unlimited; maximum loss $7,000: Misconception: assigns the long investor's profile (limited loss, unlimited gain) to a short position — an exact inversion of the correct answer.
• Maximum gain unlimited; maximum loss unlimited: Misconception: correctly senses unlimited loss but forgets the gain is capped — the stock cannot fall below zero, so the gain tops out at the sale proceeds.

Verified against: FINRA SIE Content Outline §3.1

Answer: A margin account

Short sales must be executed in a margin account: the customer is selling borrowed stock, and the account must hold collateral securing the obligation to return the shares — a credit arrangement governed by Regulation T. Regulation T's cash-account provision lets a firm sell for a customer only when the security is already held in the account, or when the customer owns it and will promptly deposit it. Borrowed shares satisfy neither condition, so shorting is prohibited in a cash account (choice A) no matter how much of the proceeds the customer deposits. IRAs (choice C) and UTMA custodial accounts (choice D) operate as cash accounts, so they cannot carry short positions either — a short would require pledging the account's assets as collateral, and these accounts permit no short sales and no uncovered options. In a custodial account the custodian is already the person placing orders, so 'written approval' changes nothing. When a question says 'sell short,' the account answer is margin.

The Trap: short sale permitted in a cash account

• An UTMA custodial account, with the custodian's written approval: Misconception: custodial UTMA/UGMA accounts are cash accounts holding irrevocable gifts for a minor's benefit — short selling is off-limits, and since the custodian is already the person who acts on the account, 'custodian approval' adds nothing.
• The customer's traditional IRA: Misconception: retirement accounts operate as cash accounts. A short position would require pledging IRA assets as collateral for borrowed stock, which is not permitted — no short sales and no uncovered options.
• A cash account, provided the customer deposits the full sale proceeds: Misconception: a classic trap — short sales are prohibited in cash accounts regardless of any deposit. Regulation T lets a firm sell for a cash-account customer only when the security is already held in the account or the customer owns it and will promptly deposit it; borrowed shares meet neither test.

Verified against: Regulation T §220.8(a)(2) (permitted cash-account transactions) and §220.12(c) (short-sale margin requirement)

Answer: Must pay $300 to the lender of the shares

Because the shares were borrowed and sold, the buyer who purchased them is the shareholder of record and collects the issuer's dividend. The lender of the shares still expects that income, so the short seller must make the lender whole with a substitute 'payment in lieu' of the dividend — here 400 x $0.75 = $300 — normally debited from the short seller's margin account automatically under the firm's margin and stock-loan agreements. The SEC states the rule plainly: if the stock you borrow pays a dividend, you must pay the dividend to the person or firm making the loan. Choice A is the classic trap: the short seller sold the shares and has no dividend entitlement — shorting a dividend-paying stock creates dividend expense, not income. Choice B wrongly assumes the dividend disappears during a stock loan. Choice C wrongly has the issuer paying twice; a company pays only its holders of record. Note the timing hook: what creates the obligation is being short over the ex-dividend/record date, not being short on the payable date. Dividends owed to the lender — along with margin interest and stock-borrow fees — are a reason a short position in a dividend payer costs more to carry.

The Trap: short seller keeps the dividend

• Receives $300, because the shares were sold out of his account: Backwards. The short seller sold borrowed shares and holds no dividend entitlement — the buyer of those shares collects the dividend. Shorting a dividend payer creates dividend expense, not income. This is the classic 'short seller keeps the dividend' trap.
• Has no obligation, because neither party receives dividends while shares are on loan: The dividend does not vanish during a stock loan. The issuer still pays it to the holder of record, and the lender still expects that income — so the short seller must make the lender whole.
• Has no obligation, because the issuer pays the dividend to both the buyer and the lender: Issuers pay only their own shareholders of record — here, the buyer of the shorted shares. The company does not pay the dividend twice; the lender is made whole by the short seller, not by the issuer.

Verified against: FINRA SIE Content Outline §3.1; SEC/investor.gov Investor Bulletin: An Introduction to Short Sales

Answer: Locate the security — that is, have reasonable grounds to believe the shares can be borrowed and delivered when due

SEC Regulation SHO Rule 203(b)(1) imposes the 'locate' requirement: before accepting a customer's short sale order in an equity security, a broker-dealer must have borrowed the shares, entered into a bona fide arrangement to borrow them, or have reasonable grounds to believe the shares can be borrowed so they can be delivered by the date delivery is due — and must document that compliance. Any one of those three satisfies the rule; together they are the safeguard against abusive 'naked' short selling and failures to deliver. (The stem says 'generally' because the rule carves out narrow exceptions, such as bona fide market making and a seller who is deemed to already own the security.) Choice A describes a long sale; the belief that short sellers must own the shares confuses shorting with closing a long position — a short sale is by definition a sale of borrowed shares. Choice B is precisely the naked-shorting practice the rule targets: the borrow must be addressed before the order is accepted, not left hanging until settlement. Choice D reverses the account rule: short sales are effected in margin accounts, where collateral secures the share loan, not in cash accounts.

The Trap: no locate needed until settlement (naked shorting)

• Move the order to the customer's cash account for execution: Misconception: reverses the account rule — short sales are effected in margin accounts, not cash accounts.
• Confirm that the customer already owns the shares being sold: Misconception: 'short selling = selling stock you own' — ownership would make it a long sale; short sales by definition involve borrowed shares.
• Take no action, because shares need to be borrowed only if the position is still open at settlement: Misconception: naked-shorting error — Regulation SHO requires the borrow question to be resolved before the order is accepted, not after the fact.

Verified against: SEC Regulation SHO Rule 203(b)(1) (17 CFR 242.203(b)(1)), locate requirement — verified via finra.org Regulation SHO guidance

Answer: Long call and short put

A bullish option position gains when the stock rises and loses when it falls. A long call gains value as the price climbs — it turns a profit once the stock clears the strike plus the premium paid. A short (written) put profits when the stock stays at or above the strike: the put expires worthless, the writer is never assigned, and the premium is kept as the full profit. A falling stock is what hurts the put writer, which is why the short put sits on the bullish side of the map (bullish-to-neutral: it wants the stock up or at least holding). Choice B assumes any purchased option is bullish, but a long put is bearish — it gains as the stock falls. Choice C assumes any written option is bearish; the short put is bullish-to-neutral, but the short call in that pair is genuinely bearish, so the pair fails the 'both' test. Choice D is the bearish pair — long put and short call — the mirror image of the correct answer. One caution on the short put: the writer keeps the premium no matter what happens; the premium is only pure profit when the put expires worthless. If the stock drops, assignment forces the writer to buy shares at the strike, and that loss can swamp the premium. Anchor the sentiment map: long call / short put = bullish; long put / short call = bearish. It lines up with stock positions — long stock = bullish, short stock = bearish.

The Trap: short put treated as bearish

• Long put and short call: Misconception: direction flip — this is the BEARISH pair, the mirror image of the correct answer.
• Long call and long put: Misconception: assumes buying any option is bullish — a long put is bearish, gaining value as the stock falls. Bought together they are a volatility play, not a bullish one.
• Short call and short put: Misconception: assumes writing (selling) any option is bearish — the short put is bullish-to-neutral. But the short call in this pair IS bearish, so the pair is not both bullish.

Verified against: FINRA SIE Content Outline §3.1.1 Orders and Strategies ("Long and short, naked and covered"; "Bearish and bullish")