FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client purchases 100 shares of XYZ stock at $50 per share. To generate additional income, the client sells 1 XYZ 55 Call option for a premium of $3. What is the maximum profit the client can achieve with this covered call strategy?
- A$800
- B$500
- C$300
- D$5,300
Show answer & explanationAnswer & explanation
Correct answer: A. $800
The maximum profit for a covered call occurs if the stock price rises to or above the strike price. The profit is the difference between the stock acquisition price and the strike price, plus the premium received. ($55 strike - $50 stock purchase) + $3 premium = $5 + $3 = $8 per share. For 100 shares, the maximum profit is $800.
Why the other options are wrong
- B. This is the capital gain on the stock if it's called away at the strike price, ignoring the premium.
- C. This is only the premium received for the call option.
- D. This represents the initial cost of the stock plus the premium, not the maximum profit.
Covered Call Maximum Profit
The highest possible profit an investor can earn from a covered call strategy, which involves owning shares of stock and selling call options against them.
- Occurs if the stock price rises to or above the call option's strike price.
- Formula: (Call Strike Price - Stock Purchase Price) + Premium Received.
- The strategy generates income but caps potential upside gains on the stock.
Memory trick: Covered Call: Stock sold at strike, plus the call's fee.