What characterizes a short call option?

• A. Unlimited downside potential with limited upside
• B. Limited downside potential with unlimited upside
• C. Zero risk
• D. Fixed profit potential

Answer: (A)

A short call option is characterized by unlimited downside potential with limited upside because the seller (or writer) of the call option obligates themselves to sell the underlying asset at the strike price if the option is exercised by the buyer. When a trader writes a call option, they receive a premium upfront, which is the maximum profit they can earn from the transaction. However, if the market price of the underlying asset rises significantly above the strike price, the seller faces potentially unlimited losses, as they will have to purchase the underlying asset at a higher market price to sell it at the lower strike price.

This structure creates a scenario where the downside risk is uncapped—if the asset price continues to soar, losses can accumulate indefinitely—whereas the upside reward is confined to the initial premium received. Understanding this risk profile is critical for options traders, as it highlights the significant obligations that come with writing options and the need for careful risk management.