Options question covered call (puzzled)

CFA Level III
#1
Company Share Price Call Premium Option Date/Strike Put Premium
9.45 April/87.50 1.67
IZD 93.93 2.67 April/95.00 4.49
1.68 April/97.50 5.78

Based on Exhibit 1, Nuñes should expect Strategy 2 to be least profitable if the share price of IZD at option expiration is:

  1. less than €91.26.
  2. between €91.26 and €95.00.
  3. more than €95.00.

Answer is A but I wrote down C. Why A? covered call profit is (strike- stock price)+ call premium. You make gains to the extent of the exercise and then you lose out gains to call buyer.

#2

What is Strategy 2?

#3

@S2000magician

Its * Strategy 2: Buying 100 shares of IZD and writing the April €95.00 strike call option on IZD

#4

Have you drawn the payoff diagram and the profit diagram?

1 Like
#5

@S2000magician No I have not. I thought I understood the formula here enough to not do that. I guess I don’t

#6

The payoff on a covered call looks like this: /¯, as does the profit diagram.

#7

Short put is the payoff for cover call.

Just adjust option premium to stock price. Short put loses when prices go down.

#8

|If the stock price goes below 91.26, the position will be the least profitable among the given choices.

Current price - less call premium received
93.93 - 2.67=91.26

#9

@S2000magician. It does not make sense if we look at the formula for max profit which is (strike- stock) + call premium. I understand the payoff diagram but I also understand the formula. Which means to say I am confused

#10

The formula for max loss is s-c.= Don’t need to use max profit formula.

#11

The question is asking about the lowest profit, not the highest. The formula for the maximum profit won’t help you here.