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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Strategies using Equity Futures and Equity Options

An investor owns a stock and sells a call option against it, as in a covered call. Compared with holding the stock alone, which statement is correct?

In a covered call the upside is capped at the strike level because the call may be exercised, while the premium received provides a small cushion against price falls. Downside is only partly reduced, not eliminated.

  1. AUpside is capped and a premium is received, cushioning small fallsCorrect
  2. BDownside is eliminated completely
  3. CUpside is unlimited and a premium is paid
  4. DLoss is limited to the premium received

Explanation

The covered call writer receives a premium, which offsets small declines, but gives up gains above strike plus premium. The stock can still fall substantially, so downside is not eliminated.

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