Per the Vignette:
“At the beginning of the meeting Sampras states: “My investment in Eagle Corporation stock has increased considerably in value, and I would like suggestions on options strategies I can use to protect my gains.” Silva responds: “There are two strategies that you may wish to consider: covered calls or protective puts. Covered calls provide a way to protect your gains in Eagle Corporation stock. Adding a short call to your long position in Eagle stock will provide protection against losses on the stock position, but it will also limit upside gains. A protective put also provides downside protection, but it retains upside potential. Unlike covered calls, protective puts require an upfront premium payment.””
- Is Silva’s response to Sampras regarding reducing exposure to Eagle Corporation stock most likely correct?
A. Yes. B. No, he is incorrect about covered calls. C. No, he is incorrect about protective puts. Answer = B B is correct. Silva is incorrect about covered calls. Covered calls do not provide protection against downside losses. They do limit upside gains. My take:** So maybe I’m over-analyzing this too much…my initial thought was “B”, BUT I found an argument for “A” too. I know covered calls don’t protect against downside losses completely, but don’t they at least help protect against SOME of the downside losses in the amounts of the premiums received? I thought CFAI was being tricky with the wording on this quesion, and that ‘A’ could have been correct as well. Let me know what you think. SO done with studying.**