CFA Level I · CFA Level I Exam · Derivative Instrument and Derivative Market Features
An investor buys a European call option on a stock with a strike price of 50. The investor's maximum possible loss at the outset of the position is most likely:
The call buyer's maximum loss is the premium paid. The buyer holds a right, not an obligation, so the option is left unexercised if it is out of the money. Potential gains are unlimited, but losses are capped at the premium.
- AUnlimited, because the stock price could rise without limit
- BThe premium paid for the optionCorrect
- CThe strike price minus the premium paid
Explanation
The buyer of an option pays the premium up front and has the right, not the obligation, to exercise. If the option expires out of the money, the buyer loses only the premium. Unlimited loss applies to a short call, not a long call.
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