FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client purchases 100 shares of XYZ stock at $70 per share and simultaneously sells 1 XYZ Oct 75 Call for a premium of $3. What is the maximum profit the client can realize from this strategy?
- A$500
- B$7,800
- C$800
- D$7,500
Show answer & explanationAnswer & explanation
Correct answer: C. $800
This is a covered call strategy. The maximum profit is achieved if the stock price rises to or above the call option's strike price. The profit is the difference between the strike price and the purchase price of the stock, plus the premium received.
Why the other options are wrong
- A. This only accounts for the stock appreciation up to the strike price, missing the premium.
- B. This includes the proceeds if called away plus the premium, but doesn't subtract the original stock cost.
- D. This represents the proceeds if the stock is called away at the strike price, not the profit.
Covered Call Maximum Profit
The highest profit an investor can make from a covered call strategy, occurring when the stock price rises to or above the strike price of the sold call option.
- Strategy involves buying stock and selling a call option on that stock.
- Maximum profit is limited to the strike price minus the stock purchase price, plus the premium received.
- Profit is realized if the stock is called away at the strike price or expires out-of-the-money.
Memory trick: Covered Calls: Covered stock, Cash premium, Capped upside.