Amy Owns 100 Shares of ABC Stock with a Cost

question 101

Essay

Amy owns 100 shares of ABC stock with a cost basis of $35 a share. The stock is currently trading at $54 a share. Amy believes the price of ABC stock will fall to $45 a share in the near future but over the longer term of 3 to 5 years, increase in value to $75 a share. Amy would like to benefit from the expected near-term decline if it occurs. Therefore, Amy writes a covered call at a strike price of $55 and a premium of $2.
(a) How will the covered call help Amy profit if the expected price decline occurs?
(b) What is the maximum loss Amy can incur from the call?
(c) What is the maximum profit Amy can incur from the call?

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