Archive / Investment Adviser (Level 2) / Non-Life Insurance Products
nism-series-xb-covered-call-option-strategy-payoff[ INVESTMENT ADVISER (LEVEL 2) ]
An investor holds 100 shares of a stock purchased at ₹1,000 and sells a 1-month Call Option with a Strike Price of ₹1,050 for a premium of ₹35. What is the Maximum Profit per share and the Downside Breakeven Price?
[ A ]Maximum Profit = ₹85 per share; Downside Breakeven Price = ₹965 [ Max Profit = (1,050 - 1,000) + 35 = 85; Breakeven = 1,000 - 35 = 965 ][ CORRECT ]
[ B ]Maximum Profit = ₹35; Downside Breakeven = ₹1,000
[ C ]Maximum Profit = Unlimited; Downside Breakeven = ₹0
[ D ]Maximum Profit = ₹1,050; Downside Breakeven = ₹1,050
Takeaway
Option A is correct: Maximum Profit = ₹85 per share; Downside Breakeven Price = ₹965 [ Max Profit = (1,050 - 1,000) + 35 = 85; Breakeven = 1,000 - 35 = 965 ]
Derivation
A covered call caps upside at the strike price while the premium received cushions the downside. The maximum stock appreciation the holder can capture is Strike minus Cost: ₹1,050 − ₹1,000 = ₹50, since beyond ₹1,050 the buyer of the call exercises and takes the shares away at that price. Add the ₹35 premium received for writing the call: Maximum Profit = ₹50 + ₹35 = ₹85 per share. On the downside, the premium acts as a partial buffer before the position starts losing money: Breakeven = Cost − Premium = ₹1,000 − ₹35 = ₹965. Below ₹965 the position loses money just like plain stock ownership, since the premium has already been fully absorbed by that point and offers no further protection.
Why the others fail
B — Maximum Profit = ₹35; Downside Breakeven = ₹1,000
Counts only the ₹35 premium, missing the ₹50 of capital appreciation the holder can still capture as the stock rises from ₹1,000 up to the ₹1,050 strike.
C — Maximum Profit = Unlimited; Downside Breakeven = ₹0
Selling a call obligates the writer to hand over shares at the strike price, which caps maximum profit; the upside is bounded, not unlimited.
D — Maximum Profit = ₹1,050; Downside Breakeven = ₹1,050
Ignores that the ₹35 premium received cushions losses below the purchase price; the correct downside breakeven is ₹965, not the full ₹1,050 strike price.
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