An investor writes a covered call with a strike price of $44 on a stock selling at $40 for a $3 premium. The range ofpossible payoffs to the writer of this covered call on the combinedposition is: A. -$40 to $47. B. $4 to $7. C. -$37 to $7. D. $7 to infinity. The correct anwser is C, but i can’t figure it out, especially for the $37 loss For me, a covered call loss happen when stock price exceeds the strike price more than the premium, but how can we suppose this future price ??? buy the way, do the buyer know that his call is a covered call???
What if the stock drops to zero?
investor pockets 3 bucks, and bought for 40, so his effective cost is 37 so C is the answer. if stock falls below 37, then -ve payoffs, otherwise always at most a profit of 7.
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the buyer of the call could care less if its covered call or not. wtf does he care. all he hopes that teh stock goes above 44 in the above case + trransaction cost for him to make any money, and hopefully it does well before expiration.
L3 Buckaroo Wrote: ------------------------------------------------------- > 1) Receive $3, short at $40; stock drops to $0, > net loss is (-40+3) = -37 > 2) Receive $3, short at $40; stock rises to $80, > net gain is: a) gain on short: (80-40 = 40); b) > loss on call: (44-80 = -36) for net gain of $4; > add the $3 premium = $7 I don’t know what you’ve done, probably from book but if you think it its fairly straighforward. no need for all this math.
An investor writes a covered call with a strike price of $44 on a stock selling at $40 for a $3 premium. The range ofpossible payoffs to the writer of this covered call on the combinedposition is: A covered call strategy is as follows: Short call + Long Assets Now, looking at the payoff, we can see that the max loss is equal: Premium received - Stock price = -37 (This happen as you bought the stock and hence the max loss in case the stock price drop is equal to the value of the stock net the premium paid) Max gain= strike price - (Premium received - Stock price ) 44 - 37= 7 (if you look at the payoff of a short call, the max amount you can gain is equal to this amount). Note:Of course the buyer knows, actually, the buyer construct the strategy.
bah - I blew it, not sure why I assumed the stock is shorted…geez. max loss is $40 on the stock offset by $3 on the premium => -$37…max gain is diff btw gain on stock vs loss on written call, always fixed at $4, plus the $3 prem = $7 Ahh, that feels better.
like pepp said, the buyer doesn’t know whether it is covered or not.
ah ok I just didn’t take the $40 to buy the stock as a cost (lose my head for a second :>! hope that woudn’t happen on the 7th) ok otherwise good sense works well in this case, no need for math YEAH !!!
Dreary Wrote: ------------------------------------------------------- > like pepp said, the buyer doesn’t know whether it > is covered or not. Dreary, it depends… if we are talking about a retailer not, but if we consider that people who build up the strategy is a trader of another specialist…of course yes. But I guess, we dont talk about the small investor who goes and ask to have some exposure on a stock
Only the clearinghouse knows.
Also remember the guy who writes covered call, he has long term view the stock will do well, but in short term he is feeling uncertain, so as a way to make quick bucks he writes the call while protecting him against infinite losses that comes with writing a naked call. also covered call you are always limiting your upside potential. also you’ll note that in real life don’t f.around with options cuz then you’ll be broke like me.
nothing is free in this world but your advice !!! You all are too great !!! THANKS ALOT !
strangedays Wrote: ------------------------------------------------------- > Dreary Wrote: > -------------------------------------------------- > ----- > > like pepp said, the buyer doesn’t know whether > it > > is covered or not. > > > Dreary, it depends… if we are talking about a > retailer not, but if we consider that people who > build up the strategy is a trader of another > specialist…of course yes. > But I guess, we dont talk about the small investor > who goes and ask to have some exposure on a stock most retailers go via brokers. no one has to know who wrote or who sold, except the brokers who keep the accounts of the buyers and sellers.
Dreary Wrote: ------------------------------------------------------- > Only the clearinghouse knows. So if you go to a bank and buy a structured product which gives to you 100% capital guarantee and at the same time 100% exposure of the upside performance of a stock underlying…you dont know how this product is structured? Actually, if you look at the marketing material of many banks, they show how the product they are marketing is structured. What we dont know are the technical parts such as: gamma, vega, delta, if the option is at the money or out of the money… and so on…
well ofcourse the call contract specifies who is writing it etc.
pepp Wrote: ------------------------------------------------------- > well ofcourse the call contract specifies who is > writing it etc. correct, and hence you know the structure of the product (i.e. if it has a call or put option embedded) but you dont know the technical part
strangedays Wrote: ------------------------------------------------------- > pepp Wrote: > -------------------------------------------------- > ----- > > well ofcourse the call contract specifies who > is > > writing it etc. > > > correct, and hence you know the structure of the > product (i.e. if it has a call or put option > embedded) but you dont know the technical part nopes. let’s say i wrote a call. the buyer could think its a naked call, where as I could have bought securities at yet another brokerage. so you can’t tell the structure of the call, except the fact that it promises to deliver underlier at a certain price upto a certain date.
strangedays, maybe so, but why should you know? Does it make a difference to your strategy whether the call you received was covered or not?