tycoon

An investor purchases a stock for $38 and a put for $0.50 with a strike price of $35. The investor sells a call for $0.50 with a strike price of $40. What is the maximum profit and loss for this position?

A) infinite profit and maximum loss = -$4.00.

B) maximum profit = $3.00 and maximum loss = -$34.00.

C) maximum profit = $2.00 and maximum loss = -$3.00.

D) maximum profit = $3.00 and maximum loss = -$4.00.

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Answer and Explanation

The option position described is a zero cost collar. It is zero cost because the premium paid for the protective put is offset by the premium received for writing a covered call. The collar will put a band around the prospective returns by limiting the upside and downside of position. The upside will be limited by the strike price on the covered call ($40), while the downside will be limited by the strike price of the put ($35).
Maximum profit = $40 - $38 = $2
Maximum loss = $35 - $38 = -$3