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 a premium of $3. What is the maximum profit this investor can realize on this strategy?
- A$300
- B$800
- C$550
- D$500
Show answer & explanationAnswer & explanation
Correct answer: B. $800
This is a covered call strategy. The maximum profit is achieved if the stock price rises to or above the strike price of the call option. The profit consists of the difference between the strike price and the purchase price of the stock, plus the premium received. (55 - 50) + 3 = $8 per share. For 100 shares, that's $8 * 100 = $800.
Why the other options are wrong
- A. This only represents the premium received from selling the call option, not the total maximum profit.
- C. This calculation is incorrect. It might represent the strike price less the premium ($55 - $3) x 100, which is not the maximum profit.
- D. This only accounts for the stock appreciation up to the strike price ($5 per share x 100 shares). It misses the premium received.
Covered Call Maximum Profit
The highest possible profit an investor can make from a covered call strategy, which occurs if the stock price closes at or above the call option's strike price at expiration.
- Strategy involves owning 100 shares of stock and selling one call option against it.
- Maximum profit is limited to the strike price minus the stock purchase price, plus the premium received.
- Occurs when the stock price is at or above the call's strike price.
Memory trick: Covered calls cap gains, but collect cash.