Question

What are the maximum gain and maximum loss to a trader that buys a call option?

Answer 1

A call option is a financial contract in which the buyer ie., Holder of the call option has the right to buy at a specified future date the security or the asset at a specified rate which is called STRIKE PRICE. The buyer has only the right but not the obligation.

The trade-off to the trader that buys a call option:

Maximum Loss: The maximum loss to a trader that buys a call option is limited to or restricted to the amount of premium paid to buy the call option.

Maximum Gain: The Maximum gain to a trader that buys a call option is potentially unlimited or limitless.

Let us consider an example.

Suppose Mr. A buys a call option at a strike price of $100 for which he paid a premium of $5.

In the Future at the specified date if the actual price of the stock is below $100, say $95, he would not exercise his option because the same stock is available at a lower price in the market. Here his loss is restricted to $5 which is the premium paid.

In a contracting situation, if the actual price of the stock in the future at a specified date is above $100, say $110, he would exercise his option to buy the stock at $100. He would gain $10 if the sell the same in the market at $110.

However, the net gain will be the Difference between the market price and the strike price less premium paid.

In this case it is ($110 - $100) - $5 = $5