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FRM Part I · FRM Exam Part I · Options Markets

An investor buys 100 shares of a stock at $50 and sells 1 call contract (100 shares) with strike $55 for $3 per share. A second investor instead buys a 1 put contract on the same stock with strike $45 for $2 per share while holding 100 shares bought at $50. Which statement about maximum profit and loss, ignoring commissions and dividends, is correct?

The covered call has a maximum profit of $800 and maximum loss of $4,700, while the protective put has a maximum loss of $700 and unlimited upside. The call premium reduces the stock's cost basis to $47, and the put premium adds to the cost.

  1. ACovered call: max profit $800, max loss $4,700; protective put: max loss $700, unlimited profitCorrect
  2. BCovered call: max profit $500, max loss $4,700; protective put: max loss $700, unlimited profit
  3. CCovered call: max profit $800, max loss $4,700; protective put: max loss $500, unlimited profit
  4. DCovered call: max profit $800, max loss $5,000; protective put: max loss $700, unlimited profit

Explanation

Covered call: max profit = (55-50+3) x 100 = $800; max loss = (50-3) x 100 = $4,700 if the stock goes to zero. Protective put: max loss = (50-45+2) x 100 = $700; profit is unlimited as the stock rises. Option B understates the call profit by omitting the premium; C uses the put loss without the premium.

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