Question #45 on 2013 mock, answer is C because covered call doesnt set minimum value. Isnt a minimum value set at S-C?
The maximum you will lose is the stock price minus the gain from the call you sold. Isnt that a mimum value set by taking covered call?
Covered Call doesn’t protect you from losing the value of the underlying. it reduces volatility.
Covered Call works like this.
You own the stock (underlying) say its at 100.
You sell a call with a strike at 120 and premium cost of 5, which limits your upside to 100-120. If the stock falls to 0 you have no downside protection.
The premium however will reduce volatility. Say the stock drops to 95. The premium covers it. Less volatility.
You get a premium so you won’t lose until price goes above $125. your max loss is cost basis of stock and gain 25.
I had the same question as detsaw - in my opinion the option premium you receive should be a set minimum value?
But it doesn’t protect your investment should the stock go to 0, I think is the point. It technically sets a max loss, but you’d have a max loss set anyway, if you hadn’t sold the call - but doesn’t set a minimum value of the underlying, like a protective put would.
I just took the 2013 mock and had the same problem with #45. The question asks about setting a minimum value not protecting the downside. I do agree that the call premium you get is essentially a minimum (non-zero) value for the position. I think the question is poorly worded and of course I got it wrong!!!