If I provide a very large answer option for a 'Label Image' question in Lt, can this still be dropped into the smaller answer area?

Lt scales labels / answer locations in 2 ways. The size of all labels will increase based on the largest possible answer you've written (to a point):
servlet.ImageServer?id=015w0000005FXVG&oid=00D20000000HncM
In addition, if you have a long label, when you drag and drop the label in to a label location, Lt will reduce the (font) size of the label to fit the location:
servlet.ImageServer?id=015w0000005FXVL&oid=00D20000000HncM