An investor purchases a stock for $65 and writes a call option on the same stock

Question

An investor purchases a stock for $65 and writes a call option on the same stock with an exercise price of
$70 for a premium of $4 per share. The call option expires in one year. Assume that the stock pays no
dividends, there are no transactions costs or taxes, and the investor will sell the stock in one year, exactly
when the option expires.
a) What is the maximum profit the investor can earn on the combined “covered call” position?
b) What is the lowest possible profit from the combined investment?
c) It is now exactly one year later and the investor tells you that the profit on the combined “covered
call” position is $4. What is the stock price today based on that information?

Explanation / Answer

a) Maximum profit $ 9.00 (70-65)+4 b) Lowest possible profit $ 4.00 Option premium received c) Profit is $4, that means option purchaser not exercised his option. Option purchaser does not exercise the option if the share price is less than $70. Hence, share price is

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