General Securities Representative (Series 7) Practice Exam

Which of the following statements about the buyer of an index option is correct?

1. The buyer has unlimited risk

2. The buyer pays the premium

3. The buyer receives dividends

4. The buyer must sell the option

The correct answer is: The buyer pays the premium

The assertion that the buyer pays the premium is correct because when someone purchases an index option, they are required to pay an upfront fee known as the premium. This premium is the cost of obtaining the right, but not the obligation, to buy or sell the underlying index at a specified strike price before or at expiration. In terms of the context of options trading, it is important to clarify that the buyer of an index option does not have unlimited risk. Instead, their risk is limited to the amount of the premium they paid. Also, buyers of index options do not directly receive dividends, as index options are based on the performance of the index and do not provide ownership in the underlying stocks. Additionally, the buyer of an index option does not have to sell the option; they have the option to either exercise it or let it expire, depending on market conditions. Thus, paying the premium is a fundamental aspect of buying options, making this statement about the buyer of an index option accurate.