CFA Practice Question

CFA Practice Question

The maximum loss on a covered call position is equal to:
A. the stock price at expiration minus the strike price plus the call premium.
B. the original stock price minus the call premium.
C. the strike price minus the call premium.
Explanation: 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 and loses otherwise. The maximum loss will occur when the stock price falls to zero. In that case, the original purchase price is lost but this loss is offset by the option premium received. The maximum loss on a covered call position is thus equal to the original stock price minus the call premium.

User Contributed Comments 8

User Comment
danlan Covered call is not only a call, it is a portfolio.
achu Excellent point by danlan. Need to think of this as the whole package, not just the written call
rgat Is a deep-in-the money position on my sold call not considered a loss??
Ex
S0=12
X=15
CallPrem=2
S1=30
Loss=30-15=-15
Gain=2(callPrem) + 3(Stock increase 12to15)
Net Loss = -15+2+3 = -10
So, according to (c) above:
Max loss would be 10-2=8
Why would I not consider the price I'm selling my underlying stock at in the formula for MaxCoveredCallLoss???
iambroke max loss = when underlying stock goes to zero...the stock is not called. the loss is cusioned by the premium you receive

max gain.....strike price - underlying stock + call premium. The upside potential is limited. If you didnt write the call on it you could have sold the stock in the open market for a much higher price.
mindi but isn't a covered call when you write a call with strike price equal to the price you bought the underlying stock? in that case C is correct.
jpducros no mindl, you can write out of the money call in a covered call.
jpducros sorry mindl, my response was not accurate.
I believe you can write a covered call with whatever strike price.
cwest020 If you write an in the money call you must post collateral, majority of the Covered call strategies are out of the money and at the money.
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