You have three friends who want to begin trading options. Each tells you that they will begin with trades/strategies that limit the maximum loss they can experience.
Of the following who has the potential for an unlimited loss?
- Walter who purchased a put option
- Xander who sold one call option of ABC Inc against the 100 shares of ABC Inc that he owns
- Zoey who sold an in-the-money LEAP call option
- None of the above can experience an unlimited loss
Solution: When one purchases an option (a call or a put), then he/she cannot experience an unlimited loss. When one sells an option, then it is possible to suffer an unlimited loss if it is a “naked” option, meaning no shares are owned. In this case, Zoey who sold a call option without owning shares could experience an unlimited loss as shares could increase in value to any price. LEAP stands for Long-Term Equity Anticipation and it means that the option has an expiry of more than one year. The correct answer is c.