FRM Part I · FRM Exam Part I · Trading Strategies
Compared with holding the underlying share alone, which describes the payoff of a covered call at expiration?
A covered call caps upside at the strike and provides premium income that cushions small price declines. It does not set a floor on losses, so large falls still hurt, unlike a protective put.
- AIt gains from price rises without limit and has reduced downside
- BIt sacrifices upside above the strike in exchange for premium income that cushions small declinesCorrect
- CIt has a floor on losses at the strike price
- DIt profits only if the share price falls
Explanation
Writing the call gives up gains above the strike but the premium partly offsets losses. Downside remains substantial, so no floor exists; that describes a protective put.
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