SIE Exam Practice Question 412

Correct Answer: D

Explanation:

D: An illustration is the best way to show why limited profit/limited loss is correct:

a. Example:

b. You purchase 100 shares of ABC stock at $50. You write/sell an ABC May 50 call for a premium of $3. If the stock falls to zero dollars per share (bankrupt), you lose $50 on the stock but get to keep the $3 premium. Net loss = $47/share. If the stock rises to infinity, your call gets exercised and you are OBLIGATED to deliver your 100 shares of ABC to the person exercising the call, and you will receive the $50 per share exercise price. You sold your stock at $50 and you had paid $50 for it initially --- you make nothing on the stock, but you get to keep the $3 premium --- your maximum gain is $3 per share. You have limited loss ($47 worst case) and you have limited gain ($3 best case).