NASAA Series 65, Uniform Investment Adviser Law ExaminationInvestment Vehicle CharacteristicsHard
An investor owns 100 shares of ABC stock, currently trading at $60 per share. To generate additional income and potentially reduce the cost basis of their shares, they decide to sell one ABC Jan 65 Call option for a premium of $3.00. What is the maximum profit potential for this covered call strategy, assuming the option is held to expiration?
- A$1,100
- B$800
- C$300
- D$500
Show answer & explanationAnswer & explanation
Correct answer: B. $800
The maximum profit for a covered call occurs if the stock price rises to or above the strike price. Profit = (Strike Price - Original Stock Price + Premium Received) * Number of Shares. So, ($65 - $60 + $3) * 100 = $8 * 100 = $800.
Why the other options are wrong
- A. This would imply a higher premium or a lower original stock price than given in the scenario.
- C. This would be the profit if the stock price only increased by $2 from its current price ($60 + $2 = $62) plus the premium ($3).
- D. This represents the profit from the appreciation of the stock from $60 to $65 ($5 * 100 = $500), without including the premium.
Covered Call Strategy
An options strategy where an investor owns shares of a stock and sells (writes) call options against those shares, generating income via the premium.
- Generates income (premium) from selling the call.
- Limits upside potential on the stock if it rises above the strike price.
- Provides partial downside protection up to the premium received.
- Investor is obligated to sell the stock if the option is exercised.
Memory trick: Covered Call max profit: Stock gain to strike + premium.