NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsMedium
A technician is analyzing market trends and believes that a particular stock, XYZ Corp., will remain relatively stable in price over the next three months, but does not expect significant upward movement. The technician owns 200 shares of XYZ Corp. and wants to generate additional income from their existing position. Which of the following strategies would be most appropriate?
- ASelling XYZ Corp. shares short
- BBuying a put option on XYZ Corp.
- CSelling a covered call on XYZ Corp.
- DBuying a call option on XYZ Corp.
Show answer & explanationAnswer & explanation
Correct answer: C. Selling a covered call on XYZ Corp.
Selling a covered call generates premium income for the shares owned. This strategy is appropriate for a stable or slightly declining stock, as the investor benefits from the premium without expecting significant upward movement that would lead to assignment.
Why the other options are wrong
- A. Selling shares short is a highly bearish strategy, betting on a significant price decline, and involves high risk.
- B. Buying a put option is a bearish strategy to profit from a price decline or protect against it, not to generate income from a stable stock.
- D. Buying a call option is a bullish strategy, expecting a significant price increase, which contradicts the technician's view of stability.
Covered Call
An options strategy where an investor sells call options on a stock they already own (or 'cover' with cash). It is used to generate income from the options premium.
- Involves owning 100 shares of stock for each call option sold.
- Generates income (premium) if the stock price remains below the strike price.
- Limits upside potential if the stock price rises significantly above the strike price.
- Appropriate for stable or moderately bullish to neutral outlooks.
Memory trick: Covered Call: You own the stock, you 'Cover' your premium with it.