Q6. A covered call position is equivalent to:

A)   owning the stock and a long call.

B)   owning the stock and a long put.

C)   a short put.

Q7. The potential profits from writing a covered call position on a stock are:

A)   limited to the premium.

B)   limited to the premium plus stock appreciation up to the exercise price.

C)   greater than the potential profits from owning the stock.

Q8. Given the covered call option diagram below and the following information, what are the dollar values for points X and Y? The market price of the stock is $70, the strike price of the call is $80, and the call premium is $5.

               Point X             Point Y

A)      $80                                   $5

B)      $75                                   $15

C)      $80                                   $15

Q9. The profit/loss diagram for a covered call strategy looks like what other type of profit/loss diagram?

A)   Long put.

B)   Short call.

C)   Short put.

Q10. Donner Foliette holds stock in Hamilton Properties, which is currently trading at $25.70 per share. On the advice of this investment advisor, he conducts a covered call transaction at a strike price of $30 and at a premium of $3.50. The advisor drew the following graph to help explain the transaction.

Which of the following statements about this transaction is least accurate?

A)   The call buyer paid $3.50 for the right to any gain above $30.

B)   If the stock price falls to $23, Foliette will gain $0.80 per share.

C)   Foliette believes the stock will appreciate significantly in the near future.

Q6. A covered call position is equivalent to: fficeffice" />

A)   owning the stock and a long call.

B)   owning the stock and a long put.

C)   a short put.

Correct answer is A)

The covered call: stock plus a short call, or a short put. The term covered means that the stock covers the inherent obligation assumed in writing the call. Why would you write a covered call? You feel the stock’s price will not go up any time soon, and you want to increase your income by collecting some call option premiums. To add some insurance that the stock won’t get called away, the call writer can write out-of-the money calls. You should know that this strategy for enhancing one’s income is not without risk. The call writer is trading the stock’s upside potential for the call premium. The desirability of writing a covered call to enhance income depends upon the chance that the stock price will exceed the exercise price at which the trader writes the call.  This is similar reasoning to selling (or going short) a put. A put is in-the-money when the exercise price is above the stock price. Since the seller of a put prefers that the buyer just pay the premium and never exercise, the seller wants the price of the stock to remain above the exercise price.

Q7. The potential profits from writing a covered call position on a stock are:

A)   limited to the premium.

B)   limited to the premium plus stock appreciation up to the exercise price.

C)   greater than the potential profits from owning the stock.

Correct answer is B)        

The covered call: stock plus a short call, or a short put. The term covered means that the stock covers the inherent obligation assumed in writing the call. Why would you write a covered call? You feel the stock’s price will not go up any time soon, and you want to increase your income by collecting some call option premiums. To add some insurance that the stock won’t get called away, the call writer can write out-of-the money calls. You should know that this strategy for enhancing one’s income is not without risk. The call writer is trading the stock’s upside potential for the call premium. The desirability of writing a covered call to enhance income depends upon the chance that the stock price will exceed the exercise price at which the trader writes the call.  The owner of a stock has the rights to all upside potential. The profits for a short call are limited to the premium.

For example, say that a stock owner writes a covered call at a stock price (S) of $50 and an exercise price (X) of $55 for a premium of $4. If at expiration, the price of the stock is more than $50 but less than $55, the buyer will not exercise, and the writer will "gain" the premium plus any stock appreciation between $50 and $55. If at expiration, the price of the stock is more than $55, the buyer will exercise and the writer's gain is limited to the premium.

Q8. Given the covered call option diagram below and the following information, what are the dollar values for points X and Y? The market price of the stock is $70, the strike price of the call is $80, and the call premium is $5.

               Point X             Point Y

A)      $80                                   $5

B)      $75                                   $15

C)      $80                                   $15

Correct answer is C)

The kink in the diagram of a covered call is always at the exercise price of the option. Therefore, point X is $80. As the stock price rises above $80, the stock is called away and the maximum gain is the call premium plus the stock price gain ($80 ? $70). The maximum gain, then, at point Y is ($5 + $10 = $15).

Q9. The profit/loss diagram for a covered call strategy looks like what other type of profit/loss diagram?

A)   Long put.

B)   Short call.

C)   Short put.

Correct answer is C)

The profit/loss diagram for the covered call looks like the profit/loss diagram for a short put position. Both option positions have limited profit potential, with the potential loss equal to the strike price less the premium.

Q10. Donner Foliette holds stock in Hamilton Properties, which is currently trading at $25.70 per share. On the advice of this investment advisor, he conducts a covered call transaction at a strike price of $30 and at a premium of $3.50. The advisor drew the following graph to help explain the transaction.

Which of the following statements about this transaction is least accurate?

A)   The call buyer paid $3.50 for the right to any gain above $30.

B)   If the stock price falls to $23, Foliette will gain $0.80 per share.

C)   Foliette believes the stock will appreciate significantly in the near future.

Correct answer is C)

One reason for an investor to conduct a covered call transaction is that he believes that the stock's upside potential is limited and he wants to collect some option premiums. The call writer thus trades the stock’s upside potential for the premium. An investor is less likely to write a covered call if he believes the stock's upside potential is significant because he would be giving up the expected gains if the stock is called away.

The information about Foliette’s gains is correct. If the stock price decreases to $23.70, Foliette can realize a gain of $0.80 if he sells the stock ($23.0 value ? $25.70 + $3.50 premium).

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thanks for sharing