## Derivatives - Query?

girimpr
Posts: 5
Joined: Thu Nov 22, 2012 4:12 pm

### Derivatives - Query?

An investor buys a share of stock at \$33 and simultaneously writes a 35 call for a premium of \$3. What is the maximum gain and loss?

Maximum Gain Maximum Loss

A) \$5 \$30

B) unlimited -\$33

C) \$2 -\$35
The correct answer was A) \$5 \$30

The maximum gain on the stock itself is \$2 (\$35 − \$33). At stock prices above the exercise price, the stock will be called away from the investor. The gain from writing the call is \$3 so the total maximum gain is \$5. If the stock ends up worthless, the call writer still has the call premium of \$3 to offset the \$33 loss on the stock so the total maximum loss is \$30.

I cannot understand the maximum gain. Can someone please put to me in simple terms, would of great help!

sujithmeno
Posts: 8
Joined: Sun Jun 24, 2012 8:00 pm

### Re: Derivatives - Query?

Investor bought the share @ -33\$ (cash outflow); simultaneously he wrote a call @3\$ (cash inflow). This makes his effective investment (initial invst.) to be -30\$.

Max loss: Since 30\$ is his total investment & he owns the stock to give to call option holder incase the option holder exercises call option is 30\$.

Max Gain: He will enjoy the maximum gain when the stock price(S) reaches the strike price (X), i.e 35\$, so that he will get to keep the stock and enjoy the maximum appreciation which means his gain would be his :- current investment value - initial investment, i.e. 35-30=5

pankaj
Finance Junkie
Posts: 61
Joined: Fri Aug 03, 2012 11:24 am

### Re: Derivatives - Query?

In simple terms:

33 is outflow
35 is the exercise price, which the writer will receive, if exercised.

Therefore, the maximum gain he can make is -33 + 3 + 35 = 5

Hope this helps!