General Securities Representative (Series 7) Practice Exam

What is typically a characteristic of a call option that an investor writes on stock they own?

1. The investor is obligated to buy more shares

2. The investor retains ownership of the stock

3. The investor has unlimited downside risk

4. The investor receives a premium for selling the call

The correct answer is: The investor receives a premium for selling the call

When an investor writes a call option on stock they own, a key characteristic of this action is that the investor receives a premium for selling the call option. This premium serves as immediate income for the investor, and it compensates them for taking on the obligation to potentially sell their shares at the specified strike price if the option is exercised by the buyer. Writing covered call options allows the investor to potentially enhance returns on their existing stock holdings, as they receive this premium in addition to any dividends or capital gains from the stock itself. This strategy can be particularly appealing in a flat or moderately bullish market where the stock is not expected to rise dramatically, allowing the investor to capitalize on that premium income without losing their shares. In contrast, if the investor were to have obligations to buy more shares, there would be different mechanics involved, such as in a naked call situation; ownership retention allows them to sell while still maintaining their investment; and while there could be risk involved in stock ownership, the downside here is generally mitigated by the stock's value and the premium received. Hence, receiving a premium for selling the call is a defining aspect of this transaction.