Question

A trader sells a put option with a strike price of $40 for $5. What is the trader's maximum gain and maximum loss? How does your answer change if it is a call option?

Answer 1

Answer:

When a trader sells a put option the maximum gain/loss is QUANTIFIABLE. Meaning to say it can be calculated at any given point in time till either the expiry of the option or the exercise. In case of a call option the maximum gain can be calculated at any given time but NOT the maximum loss.

The trader’s maximum gain from the put option is $5.

The maximum loss is $35, corresponding to the situation where the option is exercised and the asset price is zero.

If the option were a call, the trader’s maximum gain would still be $5, but there would be no bound to the loss as there is in theory no limit to how high the asset price could rise.

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