FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client purchases 100 shares of XYZ stock at $70 per share and simultaneously sells 1 XYZ 75 Call for a premium of $3. What is the maximum profit the client can realize from this covered call strategy?
- A$500
- B$300
- C$800
- D$200
Show answer & explanationAnswer & explanation
Correct answer: C. $800
The maximum profit for a covered call occurs if the stock price rises above the call's strike price and the call is exercised. The profit is calculated as the strike price minus the stock purchase price, plus the premium received. ($75 strike - $70 purchase price) + $3 premium = $5 + $3 = $8 per share. For 100 shares, that's $8 x 100 = $800.
Why the other options are wrong
- A. This would be the profit if only considering the capital appreciation on the stock up to the strike price ($500).
- B. This is only the premium received, not the total maximum profit.
- D. This is an incorrect calculation of maximum profit.
Covered Call Maximum Profit
The maximum profit for a covered call strategy occurs if the underlying stock price rises above the call's strike price, leading to the call being exercised. It is calculated as the difference between the strike price and the stock purchase price, plus the premium received.
- Strategy: long stock + short call.
- Max profit occurs if stock price >= strike price.
- Formula: (Strike Price - Stock Purchase Price) + Premium Received.
- Limits upside potential of the stock.
Memory trick: Covered calls cap gains, but premium helps.