CFA - Derivatives - Risk Management Applications - Options - Covered Call Strategy

Covered Call Strategy
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b. determine the value at expiration, profit, maximum profit, maximum loss,
breakeven underlying price at expiration, and general shape of the graph of a
a Covered Call Strategy, and explain the risk management application of the strategy.
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IP (Price of the stock when the option contract is initiated) and
TP(terminal price at maturity of the stock)
X Exercise Price

Value of the option strategy at expiration

If TP ≤ X

V = TP - IP + C

If TP ≥ X

V = X - IP + C

Maximum profit occurs when the stock price exceeds the exercise price.

Maximum loss occurs if the stock price at expiration goes to zero.

Breakeven point or breakeven stock price is the stock price where the profit of the option strategy is zero.

This occurs when the stock is price IP - C.

Covered call writing is a very popular strategy among professional traders. This is because it is a low risk strategy of call writing. There are studies that showed that covered call writing is more profitable than buying options.

Many institutional investors also use a covered call writing strategy to earn extra income through call premiums.