Question

PQR stock is selling for $38 a share. A $40 call on this stock is priced at $1.00. What is your maximum profit and maximum loss if you buy the stock and write the call? How does this compare to your maximum profit and loss if you write the call but do not purchase the stock?

Answer 1

Maximum Profit in case we buy the stock and write the call is determined by the following formula:

= Exercise Price - Stock Price + Call Premium

= $ 40 - $ 38 + $ 1

= $ 3

Maximum Loss in case we buy the stock and write the call is determined by the following formula:

= Stock Price - Call Premium

= $ 38 - $ 1

= $ 37

Maximum Profit in case we write the call but do not buy the stock will be the premium amount i.e. $ 1, since in case of a call writer the maximum profit is limited to the call premium.

Maximum Loss in case we write the call but do not buy the stock will be unlimited since in case of a call writer the maximum loss can extend to unlimited loss because a call writer incurs losses as much as the stock price moves up and since the stock price can move up to any limit the loss can extend to unlimited loss.

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