Questions and Answers
What is the primary obligation of the holder of a long call option?
In the event that the stock price remains below the strike price at expiration for a long call option, what is the consequence?
What is the maximum profit potential for a writer of a short call option?
What happens if the stock price rises significantly for a short call option writer?
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Which of the following is true regarding the risk associated with a long call versus a short call option?
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What is the maximum potential loss for a holder of a long put option?
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Which of the following statements is true regarding a short put option?
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In what scenario would a holder of a long put option profit?
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What characterizes the risk of a writer of a short put option?
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What is the primary difference in profit potential between a long put option and a short put option?
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Study Notes
Long Call Option
- A long call option involves purchasing a call option contract, allowing the holder to buy the underlying asset at the strike price on or before expiration.
- The holder's rights include the option to buy but has no obligation beyond paying the premium.
- Profit potential is theoretically unlimited as the stock price can rise indefinitely above the strike price.
- Risk is limited to the premium paid for the option, so the maximum loss occurs only if the asset price drops to zero.
- Profit occurs if the stock price exceeds the strike price; if not, the option expires worthless.
Short Call Option
- A short call option entails selling a call option contract, obligating the seller to sell the underlying asset at the strike price if exercised.
- The writer has no rights linked to the option and must fulfill their obligation if the buyer exercises it.
- Maximum profit is limited to the premium received for selling the option.
- Risk is theoretically unlimited due to the potential for significant losses if the asset price rises dramatically, requiring purchase at higher market prices.
- Profit is retained if the stock price stays below the strike price; otherwise, losses can be substantial.
Long Put Option
- A long put option consists of purchasing a put option contract, granting the holder the right to sell the underlying asset at the strike price on or before expiration.
- The holder’s rights include the ability to sell while facing no obligation beyond paying the premium.
- Profit potential is significant but capped at the difference between the strike price and zero, minus the premium paid.
- Risk remains limited to the premium paid, even if the asset price escalates significantly.
- Profit is realized if the stock price falls below the strike price; otherwise, the option expires worthless.
Short Put Option
- A short put option means selling a put option contract, which obligates the writer to buy the underlying asset at the strike price if exercised by the buyer.
- The writer has no rights associated with the option but must comply with their obligations upon exercise.
- Maximum profit is limited to the premium received for writing the option.
- Risk is substantial but capped, as the asset price cannot decrease below zero. Losses occur if the asset's price falls to zero, requiring a purchase at the strike price.
- Profit is retained if the stock price remains above the strike price; if it falls below, substantial losses can occur but are contained.
Summary of Differences between Call and Put Options
- Long Call vs. Long Put: Long calls grant the right to buy with unlimited profit potential; long puts grant the right to sell with significant yet limited profit.
- Short Call vs. Short Put: Short calls involve the obligation to sell with unlimited risk; short puts require purchasing with substantial but limited risk.
- Understanding these distinctions is vital for informed trading and investing based on individual risk tolerance and market perspective.
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Description
Explore the fundamentals of long call options in this quiz. Learn about the rights, obligations, and profit potential associated with purchasing a call option contract. Test your understanding of key concepts and terminology relevant to options trading.