Options are one of the most heavily tested — and most feared — areas of the Series 7. Nearly every options question can be solved with four facts: who bought, who sold, the breakeven, and which way the investor wants the market to move.
The four basic positions
| Position | Market view | Breakeven | Max gain | Max loss |
|---|---|---|---|---|
| Long call | Bullish | Strike + premium | Unlimited | Premium |
| Short call | Bearish (neutral) | Strike + premium | Premium | Unlimited |
| Long put | Bearish | Strike − premium | Breakeven × 100 | Premium |
| Short put | Bullish (neutral) | Strike − premium | Premium | Breakeven × 100 |
Memory aids: Calls Up, Puts Down — add the premium to the strike for calls, subtract for puts. The buyer and the seller of the same option always share the same breakeven. Buyers want volatility and exercise; sellers want the option to expire.
Options combined with stock
| Position | Purpose | Breakeven | Max gain | Max loss |
|---|---|---|---|---|
| Long stock + short call (covered call) | Income; partial downside cushion | Cost − premium | (Strike − cost + premium) × 100 | Breakeven × 100 |
| Long stock + long put (protective put) | Protects a long position | Cost + premium | Unlimited | (Cost + premium − strike) × 100 |
| Short stock + long call | Protects a short position | Short price − premium | Breakeven × 100 | (Strike − short price + premium) × 100 |
Spreads and straddles
| Position | Breakeven | Max gain | Max loss |
|---|---|---|---|
| Call spread | Lower strike + net premium | Debit: strike difference − debit · Credit: the credit | Debit: the debit · Credit: strike difference − credit |
| Put spread | Higher strike − net premium | Same as call spreads | Same as call spreads |
| Long straddle | Strike ± total premiums | Unlimited | Total premiums |
| Short straddle | Strike ± total premiums | Total premiums | Unlimited |
- Debit spreads (you paid) want the premiums to widen and both options exercised. Credit spreads (you received) want premiums to narrow and both to expire.
- Bull call spread: buy the lower strike, sell the higher (debit). Bear call spread: sell the lower, buy the higher (credit).
- Bear put spread: buy the higher strike, sell the lower (debit). Bull put spread: sell the higher, buy the lower (credit).
Worked example: protecting a short sale
Question. A customer sells short 100 shares at $40 and buys 1 45 call at 2. What are the breakeven and maximum loss?
- Money in: $40 from the short sale. Money out: the $2 premium. Breakeven = $40 − $2 = $38.
- If the stock rises above $45, the customer exercises the call and buys at $45 to cover the short.
- Loss per share = $45 + $2 − $40 = $7. Maximum loss = $7 × 100 = $700.
Intrinsic value and time value
- Call intrinsic value = market price − strike (never below zero). Put intrinsic value = strike − market price.
- Time value = premium − intrinsic value.
- A call is in the money when the market is above the strike; a put is in the money when the market is below the strike.
Options rules the Series 7 tests
- Options Disclosure Document (ODD): delivered at or before account approval.
- Account approval: a registered options principal approves the account before the first trade; the signed options agreement is due within 15 days of approval.
- Settlement: options trades settle T+1; exercised equity options settle T+1 in shares; index options settle in cash.
- Exercise style: American-style can be exercised any time before expiration; European-style only at expiration.
- Assignment: the OCC assigns exercise notices to broker-dealers at random; firms may assign to customers by random, FIFO or another fair method.
- Index hedge: contracts needed = (portfolio value × beta) ÷ (index level × $100).
Options FAQ
How do you calculate the breakeven on a call option?
Strike price plus premium. A 50 call bought for 3 breaks even at $53. Remember 'calls up': add for calls.
How do you calculate the breakeven on a put option?
Strike price minus premium. A 40 put bought for 2 breaks even at $38. Remember 'puts down': subtract for puts.
What is the maximum loss on a long option?
The premium paid. A buyer can never lose more than the premium.
Which options positions have unlimited risk?
A short (uncovered) call and short stock without a hedge. A short straddle also has unlimited risk on the call side.