NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Derivatives
Which statement about the maximum loss of an option buyer versus an option seller (writer) is correct?
The buyer's maximum loss is limited to the premium paid, whereas the writer of an uncovered call option can suffer very large, theoretically unlimited losses if the underlying price rises sharply, since the writer only receives the premium.
- ABoth the buyer and writer have limited loss equal to the premium
- BThe buyer's loss is limited to the premium paid, while the writer of an uncovered call can face very large lossesCorrect
- CThe buyer's loss is unlimited, while the writer's loss is limited to the premium
- DBoth the buyer and writer face unlimited losses
Explanation
An option buyer can lose at most the premium paid. A writer receives the premium but is obliged to perform if exercised, so an uncovered call writer faces potentially unlimited loss as the price rises.
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