What is the maximum amount the buyer of an option can lose?

Expert Solution

Call option:

In case the market price of the security, on the exercise date, is higher than the option strike price, the option buyer can buy the security at the strike price. Then the difference between the market price and the strike price is gain. Amount after deducting the option premium will be the net gain or loss, as the case may be. If the market price is higher than the strike price by more than the option price, there will be net gain. In case the difference is less than the option price, there will be net loss, but subject to the maximum of the option price. In case the market price is equal to or less than the strike price, the option holder can opt not to exercise the option and limit the loss to the amount of option price paid.

Put option:

The reverse process takes place in the case of put option. In case the market price of the security, on the exercise date, is lower than the option strike price, the option buyer can sell the security at the strike price. Then the difference between the market price and the strike price is gain. Net gain or loss after deducting the option premium, as above. In case the market price is equal to or more than the strike price, the option holder can opt not to exercise the option and limit the loss to the amount of option price paid.

Common to both:

Hence the maximum loss is the option price (premium) paid.

jeff jeffy answered 2 years ago

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