FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client has a long position in 100 shares of XYZ stock, purchased at $50 per share. To generate income, the client sells 1 XYZ Call 55 for a premium of $3. At what market price will the client achieve the maximum profit on this strategy?
- A$60 per share
- B$50 per share
- C$55 per share
- D$58 per share
Show answer & explanationAnswer & explanation
Correct answer: C. $55 per share
This is a covered call strategy. The maximum profit is realized when the stock price rises to the call's strike price. At this point, the stock is called away, and the investor keeps the premium received.
Why the other options are wrong
- A. Similar to option C, any price above the strike price will result in the stock being called away at the strike price, limiting the profit.
- B. This price would result in a profit of only the premium, but not the full capital appreciation up to the strike price.
- D. While a higher price than the strike, any price above the strike price will still result in the stock being called away at the strike price, so no additional profit is made beyond the strike.
Covered Call Maximum Profit
The maximum profit for a covered call strategy is achieved when the underlying stock price rises to the strike price of the short call option.
- Strategy involves owning stock and selling a call option.
- Profit is stock appreciation up to strike plus premium received.
- Stock is 'called away' at the strike price, limiting upside.
Memory trick: Covered Calls Cap Gains, Collect Cash.