Explanation:
A covered call is long stock + short call.
If the stock rises above the strike price, the short call will be exercised and the stock is called away at $22.00.
Profit = stock sale price + option premium - stock purchase price
= $22.00 + $4.00 - $21.00
= $5.00
If the stock price falls to zero, the stock loses $21.00 in value, but the trader keeps the $4.00 premium.
Loss = $21.00 - $4.00 = $17.00
So the maximum net loss is - $17.00.
Thus, the correct answer is $5 max net profit and -$17 max net loss.
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Q-183.3. Covered call and protective put
A nine-month call option with a strike price of $22.00 has a price (option premium) of $4.00 when the underlying stock price is $21.00. If a trader writes a covered call (i.e., with the OTM call option), what are, respectively, the maximum net profit (reward) and the maximum net loss (risk) possible? note: consistent with Hull’s profit pattern charts, please disregard the time value of money.
A
$5 (max net profit) and -$17 (max net loss)
B
unlimited (max net profit) and -$21 (max net loss)
C
unlimited (max net profit) and -$17 (max net loss)
D
$5 (max net profit) and unlimited (max net loss)