Series-7 - Provides Customers with Information About Investments, Makes Recommendations, Transfers Assets and Maintains Appropriate Records - Section 3.3

Apply listed options characteristics and strategies - protective puts, covered calls, spreads, and straddles - and compute maximum gain, maximum loss, and break-even for option positions.

Apply the contract specifications, exercise and assignment mechanics, and the role of the Options Clearing Corporation (OCC) for listed equity, index, and yield-based options. Compute the maximum gain, maximum loss, and break-even for basic and advanced strategies - protective puts, covered calls, debit and credit spreads, straddles, and uncovered writing - and apply the tax treatment of premiums, exercise, and expiration.

Options Clearing CorporationCovered callProtective putSpreadBreak-even point

Practice question for this objective

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Ms. Haddad writes 1 PQR June 25 call and receives a premium of 1.50 ($150). The call is uncovered. She asks her registered representative for her maximum gain, her maximum loss, and her break-even point on this position. Which summary is correct?

AMaximum gain is $150, maximum loss is unlimited, and break-even is 23.50.
BMaximum gain is $150, maximum loss is unlimited, and break-even is 26.50. Correct
CMaximum gain is unlimited, maximum loss is $150, and break-even is 26.50.
DMaximum gain is $150, maximum loss is $2,500, and break-even is 26.50.

For an uncovered short call, maximum gain equals the premium, maximum loss is unlimited, and break-even equals strike plus premium. A naked call writer earns only the premium but must deliver stock at the strike however high the price rises, so the loss is unbounded and break-even occurs once the stock exceeds the strike by the premium received.

Why A is wrong: The break-even of 23.50 subtracts the premium from the strike, which is the long put method; a call break-even adds the premium, so the writer starts losing above 26.50.

Why B is correct: The writer keeps the $150 premium as the maximum gain; the loss is unlimited because the stock has no ceiling and the call is uncovered; and break-even is strike plus premium (25 + 1.50 = 26.50).

Why C is wrong: Unlimited gain with a $150 loss describes the long call buyer; the writer's gain is capped at the $150 premium while the loss is unlimited as the stock rises.

Why D is wrong: The loss is not capped at $2,500; a naked call writer must deliver at 25 no matter how high the stock climbs, so the potential loss is unlimited.

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