Question

The maximum possible gain of a long position in call option is __________, and the maximum possible gain of a short position in put option is __________.

Multiple Choice

• exercise price - stock price, premium

• stock price - exercise price, unlimited

• unlimited, exercise price - stock price

• unlimited, premium

Answer 1

The maximum possible gain of a long position in call option is unlimited, and the maximum possible gain of a short position in put option is premium.

In a call option, the holder foresees that the market will be increased in future. So, he buys the same today by paying some premium, in anticipation of rise in the price. Even if the price falls, the maximum loss that he will bear is the premium paid. But if the price rises, he will earn unlimited profits. So, he would like to go long in call position.

In put option, the holder foresees that the market will go down in future. So, he goes short, i.e., he sells the same today in order to avoid any loss, and gets premium by selling. When the price falls in future, the maximum profit that he earns is the premium that he earned when selling the options. On the other hand, if the price rises, the maximum loss that he will bear will be the Strike Price that he paid for buying the option net of the premium that he received when selling the same.