CFA Practice Question

CFA Practice Question

Which of the following is (are) true about option strategies?

I. A naked call position gains value when the stock price rises.
II. A covered call position gains when the stock price falls.
III. A portfolio insurance strategy gains when the stock price rises.
A. I & III
B. III only
C. II only
Explanation: A naked call position involves a pure written call option. It therefore loses value as the stock price rises. A covered call position involves a written call option with a long position in the underlying stock. This position gains value when the stock price rises until the strike price is reached. A portfolio insurance strategy consists of buying a put when you are long the underlying stock. In this strategy, your portfolio value rises when the stock price rises.

User Contributed Comments 9

User Comment
shasha naked call is a call writer's position.
ahan protfolio insurance = protective put
keithinny The puts bought in the insurance strategy expire worthless when the market goes up. Meaning that the insurance strategy performed worse than an uninsured strategy. So the strategy of insuring was a bad one and lost money.
Jimmie a covered call =writing a call; a protective put=buying a put. both are on stock that you currently own. so the put absorbs the downside in "d" above and you get to fully participate in the upside after absorption of put premium costs
shiva5555 so what do they call it when you just want to buy a call?
teje but for covered call position, if the stock price drops by more than the premium you collected than you are looking at a loss, as you also own the underlying shares.
scottm8571 This question is very vague frankly. If you are a covered call writer, your goal is to keep the premium. The entire premium is kept if the call expires worthless. It is perfect if the stock does nothing.

Meanwhile, if you are long puts, you want the stock to fall, to take advantage of a temporary dip in price.

The question would be better written if the temporary profit of the underlying would be taken out of the question, as the long-term investor sells covered calls and buys protective puts because he/she wants to maintain possession of the shares without the additional risk....Therefore, he is not focused on the return of the stock per se, but the short term profit on the options.
scottm8571 Let me further clarify why III is wrong. If I buy a put for $5 on a $50 stock, with a strike price of $50, and the stock goes up to $51, I am out $4 of premium.
GBolt93 Yes, but if the stock price remains at 50 you are out $5 of premium, therefore the portfolio gained when the stock went up. III is correct. In a portfolio insurance strategy the best outcome is always for the stock to increase. Yes you're at a loss until the stock price reaches $55, but you're always better off if it gains. It doesn't specify that you've maid a profit if it increases, only that the portfolio value increases, which is true.
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