FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client purchases 100 shares of XYZ stock at $50 per share and simultaneously sells 1 XYZ 55 Call for $3. What is the maximum profit potential for this strategy?
- A$5,300
- BUnlimited
- C$300
- D$800
Show answer & explanationAnswer & explanation
Correct answer: D. $800
This is a covered call strategy. The maximum profit is achieved if the stock price rises above the call's strike price. The profit is the difference between the strike price and the purchase price, plus the premium received.
Why the other options are wrong
- A. This incorrectly includes the full value of the stock purchase.
- B. The profit is capped at the strike price of the sold call, making it a limited profit strategy.
- C. This only accounts for the premium received, not the stock appreciation.
Covered Call Maximum Profit
The maximum profit in a covered call strategy occurs if the stock price rises above the strike price of the call. It is calculated as (Strike Price - Stock Purchase Price) + Premium Received.
- Strategy involves buying stock and selling calls against it.
- Used to generate income and offer limited downside protection.
- Maximum profit is limited, maximum loss is substantial.
Memory trick: Covered calls are like selling a ticket for a ride you own; you get paid, but you might miss out on the full thrill.