CFA Level II ExamDerivativesEasy
A portfolio manager is considering using a covered call strategy. The current stock price is $100. The manager buys 100 shares at this price and simultaneously sells a call option with a strike price of $105 for a premium of $3.00. Ignoring transactions costs, what is the maximum profit the manager can achieve with this strategy?
- A$500
- B$10,300
- C$300
- D$800
Show answer & explanationAnswer & explanation
Correct answer: D. $800
The maximum profit for a covered call occurs when the stock price is at or above the strike price. It is calculated as the strike price minus the purchase price of the stock, plus the premium received.
Why the other options are wrong
- A. Incorrect; this is the difference between strike and stock price only.
- B. Incorrect; this is the maximum possible revenue without subtracting the cost of the stock.
- C. Incorrect; this is only the premium received.
Covered Call Maximum Profit
The maximum profit for a covered call strategy occurs when the stock price is at or above the strike price of the call option.
- It is calculated as the difference between the strike price and the stock purchase price, plus the premium received.
- The investor owns the underlying stock.
- The call option is sold against the owned stock.
Memory trick: Covered Call: Stock + Sold Call, Profit Caps at Strike!