Covered call - Protective put determine, regarding, example, settled, someone

whew1110

just get confused regarding the profit or loss on covered call or protective put strategies.

Can someone just explain how the covered call for example is settled when the expectations are not met, I mean when the underlying price rise and then the asset is called away ? What is the loss then ?

Same for the protective put, from its breakeven, how do we determine the profit ? thanks

chetan86

Covered Call

Let's say you buy a stock for 30 and sell a call with a strike of 40. Premium is $5.

At expiration if St>= X, (45) your stock gets called away.
Value @ expiration is
Vt = St - Max (0,St-X )
Therefore Value at expiration Vt = 45 - Max (0,45 -40)= 40 or X. (this is always the case if St >X)
P&L is as follows :
You gain $10 for increase in the value of the stock (40-30) + the income from selling the call i.e $5 for a total profit of $15

If St was <= X,(35) then Vt = St and your profit would be (35 - 30) + Premium from call (5) = $10

When you sell a call you are betting against the price going up. You are the option seller and therefore are obligated to deliver if option is excercised.

Breakeven for covered call is S (price of underlying) - Premium received. So in the above case our cost was 30 and the premium was 5 so breakeven is $25.

My apologies for the formatting. I hope this helps

dcfox83

thanks C3PO, but still don't get why at expiration of the written call, if S>X, you still have a profit in your P&L. You'll lose the stock as well as getting a loss in your call strategy right ?

invic

Because you still have the premium from the sold call. Lets's say you bought the stock for 40 and sold a call for 40. @ expiration the stock is at 42. Your stock gets called and you get 40. But you still have the premium from selling the call, which is your profit. Sorry for not explaining properly. Hope that make sense?