United States
Hong KongOptions and futures: the four positions and what each risks
A call gives the right to buy and a put the right to sell, at a set price by a set date. Buying either risks only the premium; writing a naked call has theoretically unlimited risk. Covered calls generate income and protective puts limit downside.
The exam wants the concepts and the risk profiles rather than pricing models. This is what that amounts to. No pricing models.
The four positions
| Position | Right or obligation | Profits when | Maximum loss |
|---|---|---|---|
| Long call | Right to buy | The price rises | The premium paid |
| Long put | Right to sell | The price falls | The premium paid |
| Short call | Obligation to sell if exercised | The price stays flat or falls | Theoretically unlimited |
| Short put | Obligation to buy if exercised | The price stays flat or rises | Strike price less premium |
Buyers pay a premium and cap their loss at it. Writers receive the premium and take on the obligation, which is where the risk sits. Writers do not.
Writing a call without owning the underlying has theoretically unlimited loss, because the price can rise without limit while you are obliged to deliver. It is the only genuinely unlimited-risk position in the set, and questions test whether you know that.
The two strategies planners actually use
A covered call: own the shares, write a call against them. It generates premium income and caps the upside at the strike. Suitable for a client comfortable selling at that price, and a common way to generate income from a holding.
A protective put: own the shares, buy a put. It sets a floor under the position at the cost of the premium, which is insurance in structure and in economics.
A collar combines the two: buy a put, write a call, using the premium received to fund the premium paid. It is the standard answer for a concentrated low-basis position that cannot be sold without a large tax bill. Cost close to zero.
Intrinsic and time value
Intrinsic value is what the option is worth if exercised now. Time value is the rest of the premium, and it decays to zero at expiry. Time value decays.
An option in the money has intrinsic value. Out of the money it has none, and the entire premium is time value.
Futures
An obligation on both sides rather than a right. Standardized contracts, exchange traded, marked to market daily with margin.
Used by producers and consumers to hedge and by speculators to take a view. Rarely part of a retail financial plan, and the exam wants recognition of what they are rather than trading detail. Rarely in a retail plan.
The suitability framing
Where a question offers an options strategy, ask what problem it solves. Covered calls solve income from an existing holding. Protective puts and collars solve concentration risk that cannot be sold for tax reasons.
Anything speculative in a retail plan is generally the wrong answer.
Dollar limits and rate thresholds here are indexed annually. Confirm the current figure before relying on it, and expect the exam to test the rule rather than the number.
Common questions
What is the difference between a call and a put?
A call gives the right to buy at the strike price by expiry; a put gives the right to sell. Buyers pay a premium and cap their loss at it; writers take on an obligation.
Which position has unlimited risk?
A naked short call. The price can rise without limit while the writer is obliged to deliver, making it the only genuinely unlimited-loss position in the basic set.
What is a covered call?
Owning the shares and writing a call against them. It generates premium income and caps the upside at the strike, so it suits a client comfortable selling at that price.
What is a collar used for?
A concentrated low-basis position that cannot be sold without a large tax bill. Buying a put sets a floor and writing a call funds the premium.
What is time value?
The portion of an option premium above intrinsic value. It decays to zero at expiry, so an out-of-the-money option is entirely time value.