Series 7 Options Practice Questions
Question 1
What is the maximum potential loss to an investor who purchases (goes long) a put or call option?
- A. Unlimited
- B. The premium paid
- C. The strike price minus the premium paid
- D. The full strike price
Show answer and explanation
Correct answer: B. The premium paid
The maximum loss for a long option position (call or put) is limited to the premium paid, since the buyer can simply let the option expire worthless if it is not profitable to exercise. Choice A applies to short (uncovered) calls, not long positions. Choices C and D confuse the breakeven or strike price with the actual dollar risk, which is capped at the premium.
- A. Unlimited loss potential describes an option writer (especially an uncovered call writer), not a buyer.
- B. A long option holder can never lose more than what she paid for the contract, since she can simply let it expire worthless.
- C. This isn't a recognized maximum-loss formula for a long option; the loss is capped at the premium regardless of the strike price.
- D. The full strike price is what a put writer might be exposed to on assignment, not the loss ceiling for someone who bought the option.
Question 2
A client owns 100 shares purchased at $80, buys one 75-strike put for a $2 premium per share, and sells one 90-strike call for $3 per share. All contracts expire together, and commissions are ignored. What are the maximum total profit and maximum total loss on this combined position?
- A. $1,000 maximum gain; $500 maximum loss.
- B. $1,100 maximum gain; $400 maximum loss.
- C. $1,300 maximum gain; unlimited loss.
- D. $800 maximum gain; $700 maximum loss.
Show answer and explanation
Correct answer: B. $1,100 maximum gain; $400 maximum loss.
The collar produces a $1 net credit per share. Above $90 the shares gain $10 plus the $1 credit, or $1,100. Below $75 the shares lose $5, less the $1 credit, for a $400 maximum loss.
- A. Uses the strike prices alone and omits the $100 net option credit from both figures.
- B. Maximum gain is $10 + $1 = $11 per share; maximum loss is $5 - $1 = $4 per share.
- C. The purchased put limits the downside, so the loss is not unlimited, and the sold call caps the gain.
- D. Neither figure follows from the $80 cost, the $75 and $90 strikes, and the $1 net credit.
Question 3
An investor owns 100 shares bought for $44 and sells one $50 call for $2 per share. At expiration the stock is $57 and the call is assigned. What is the total profit ignoring commissions?
- A. $1,300
- B. $200
- C. $800
- D. $600
Show answer and explanation
Correct answer: C. $800
The shares are called away at $50 for a $6 gain per share ($600), and the $200 premium is kept, so total profit is $800. Gains above $50 are surrendered.
- A. This counts the stock's full rise to $57 plus the premium; the short call caps the gain at the strike price.
- B. This is only the premium and ignores the $600 gain from the shares being called away at $50.
- C. Strike $50 minus cost $44 is $600, plus the $200 premium, equals $800.
- D. This is the stock gain to the strike but omits the $200 premium collected.
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An investor who owns 100 shares of stock and writes 1 covered call against the position is primarily seeking to:
- A. Fully protect the position against unlimited downside risk in the stock, since the premium received offsets losses of any size
- B. Lock in a guaranteed profit on the stock whether its price rises or falls, simply by collecting the premium on the call
- C. Increase leverage and create potential for unlimited gain by participating in appreciation on additional shares beyond the 100 owned, funded by the premium received
- D. Generate additional income and gain limited downside protection equal to the premium received, while capping upside potential above the strike
Show answer and explanation
Correct answer: D. Generate additional income and gain limited downside protection equal to the premium received, while capping upside potential above the strike
Covered call writing generates income from the premium received and provides limited downside cushion equal to that premium, but it caps the investor's upside because the stock may be called away once it rises above the strike price. It does not eliminate downside risk beyond the premium amount, and it does not guarantee a profit.
- A. Overstated — the premium only offers limited downside protection equal to the amount received, not full protection against losses of any size.
- B. No options strategy guarantees a profit whether the stock rises or falls; the stock can fall by more than the premium, so this overstates the strategy's protective effect.
- C. Covered call writing is a conservative, income-oriented strategy; it does not increase leverage, fund purchases of additional shares, or create unlimited gain potential - in fact it caps gains.
- D. Correct — covered call writing generates income, offers limited downside cushion, and caps upside potential.