Which of the following statements about put options is false?
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A. B. C. D.B
The correct answer to the question is D. The statement that the most the writer of a put option can gain is the put's premium is false.
A put option is a financial derivative that gives the buyer (also known as the holder) the right, but not the obligation, to sell an underlying asset (usually a stock) at a specific price (known as the strike price) within a specified period of time. The writer of the put option (also known as the seller or the option writer) is the party who sells the put option to the buyer.
Let's examine each statement to understand why option D is false:
A. The most the buyer of a put can lose is the premium: This statement is true. As the buyer of the put option, the maximum loss you can experience is limited to the premium paid to acquire the option. This is because the buyer has the right to exercise the option and sell the underlying asset at the strike price, but is not obligated to do so. If the price of the underlying asset rises above the strike price, it is more beneficial for the buyer to simply let the option expire without exercising it, resulting in a loss equal to the premium paid.
B. The most the buyer can gain is unlimited: This statement is true. As the buyer of a put option, your potential gain is theoretically unlimited. If the price of the underlying asset decreases significantly below the strike price, the buyer can exercise the put option and sell the asset at a higher price than the current market value, resulting in a profit. The profit potential increases as the underlying asset's price falls further.
C. The most the writer can lose is the stock's price less the premium: This statement is true. The writer of a put option faces potential losses if the price of the underlying asset decreases below the strike price. In such a scenario, the buyer may exercise the option, and the writer is obligated to buy the asset at the strike price, even if the market price is lower. The writer's loss is calculated as the difference between the strike price and the market price, reduced by the premium received from selling the put option.
D. The most the writer can gain is the put's premium: This statement is false. The writer's potential gain is not limited to just the premium received. If the price of the underlying asset remains above the strike price throughout the option's life, the buyer will not exercise the option, and the writer gets to keep the premium as profit. However, there is no upper limit on the price of the underlying asset, and if it rises significantly, the writer may face substantial losses if the buyer exercises the option. The writer would have to buy the asset at the higher market price and sell it to the buyer at the strike price, resulting in a loss exceeding the premium received.
In summary, the false statement is that the most the writer of a put option can gain is the put's premium (option D). The writer's potential gains are not limited to the premium, as they can face significant losses if the price of the underlying asset rises above the strike price and the buyer exercises the option.