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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Derivatives

A PMS portfolio holds shares and writes (sells) call options on the same shares against the holding, in the same quantity. Which statement best describes this covered call strategy's outcome?

A covered call earns premium income but caps gains above the strike price. The manager holds the shares and sells calls on them, so rises beyond the strike benefit the option buyer. Downside on the shares remains, softened only by the premium received.

  1. AIt earns premium income but caps the upside above the strike priceCorrect
  2. BIt has unlimited upside and limited loss
  3. CIt profits only if the shares fall sharply
  4. DIt removes all downside risk of the shares

Explanation

The writer receives premium, which cushions small losses slightly, but if shares rise above the strike the shares are effectively called away, so gains are capped. Downside on the shares remains, reduced only by the premium. Hence the upside is limited, not unlimited.

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