FINRA Series 7Investment Information and Suitable RecommendationsMedium
An investor purchases 100 shares of XYZ stock at $60 per share and simultaneously sells 1 XYZ 65 call for a premium of $4. What is the maximum loss this investor can incur?
- A$6,400
- B$6,000
- C$5,600
- D$6,100
Show answer & explanationAnswer & explanation
Correct answer: C. $5,600
This is a covered call strategy. The maximum loss occurs if the stock price falls to $0. In this scenario, the investor loses the entire value of the stock purchase, but this loss is offset by the premium received from selling the call option. So, (Stock Purchase Price * 100 shares) - Premium Received = ($60 * 100) - ($4 * 100) = $6,000 - $400 = $5,600.
Why the other options are wrong
- A. This calculation is incorrect and does not represent the maximum loss for a covered call.
- B. This is the total cost of the stock, not accounting for the premium received.
- D. This calculation is incorrect and does not represent the maximum loss for a covered call.
Covered Call Maximum Loss
The largest potential loss an investor can experience with a covered call strategy, which occurs if the underlying stock price declines to zero.
- Results from owning stock and selling a call option against it.
- Calculated as the stock's purchase price minus the premium received for the call.
- This loss is realized if the stock becomes worthless.
Memory trick: Stock crash, but premium cushions the fall.