 Hello and welcome to the session. This is Professor Farhad, in which we would look at covered call, which is part of options strategies. This topic is covered on the CPA, BEC exam, the CFA exam, and an essential or principles of investment course. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,800 plus accounting, auditing, tax, finance, as well as Excel tutorials. If you like my lectures, please like them and share them. If they benefit you, it means they might benefit other people. And don't forget to check out my website, farhadlectures.com, for additional supplemental resources for this course. So let's talk about a call. If you have a call, it means you have to buy the stock at a certain price. What we are doing here is we are writing a covered call. It means we own the stock. We own the stock. We don't need to buy it. We own it. And what we're looking to do is to make the goal is to make some extra income, to sell this call and make some extra income. So how this whole thing work? Let's assume you own a stock and you paid for that stock. Your stock price for you is $50. What you do is this. You would write a covered call. It means you sell a call with a strike price of 55. What does that mean? And let's make it for 60 days. It means in the next 60 days you are willing to sell this stock for $55. Now, what you do is you also get a premium. When you sell this contract, well, somebody's gonna pay you because you're giving them the right to buy your stock at a certain price. Therefore, let's assume the premium equal to $2. So you receive $2 today. You tell them, look, between now and the next 60 days, I'm willing to sell you my stock price for $55. Now, the other party, they're hoping that the stock price goes above $55. Specifically, they're looking for the stock to go above $57. That's on their end. This is where they start to make profit. From your side, you're thinking the price is not gonna go up above $55. So I'm gonna keep this $2 and I'm not gonna hear anything from them. And by getting $2, basically think about it. By getting this $2 premium, what you did is, in a sense, you reduced your stock basis to 48. So now your basis, your stock price is really, let's not use the stock basis, it's a tax term. Well, your basis, not stock pay. Yeah, you reduced your basis to 48. Basically, you paid 48. Your net cost is now $48, okay? Now, so how do we kind of graph this information discovered call? So here's what's gonna happen. We're gonna have a vertical line. This is gonna be the profit and loss line. And we're gonna have a horizontal line for the stock price. And our stock price is $50. This is our stock price. This is the profit at loss zero. This is the loss part. This is the profit. And here's what's gonna happen. The line for your stock at $50 by itself is whatever, it's a line with a slope of one. So if the stock price goes one, you make a dollar. If the stock price goes down a dollar, it goes down to 49, you lose a dollar. So it's a vertical line. So this is one, two, three, negative one, two, three pluses. So that's pretty straightforward. What happened that was this, you received $2. And by receiving this $2, you already have a profit of $2. And guess what? You can keep this profit basically. Well, not let's talk about the profit first, but let's talk about the strike price before we talk about the profit. The strike price is $55. So at $55, what you do is you have to give up this stock. Most likely either have to give up the stock or your option will start to lose money. But let's assume you give up the stock. It doesn't matter. So here's what's gonna happen. As long as the stock price is $55 or less, you will make $2, okay? You'll make $2, why? Because no one's gonna come back and wants to buy your stock if it's at $55 or below, why? Because they can buy it at, why would they exercise buy it at $55 if they can buy it at lower? So this is your profit up until $55. After $55, your profit will start to go down and simply put at $57 because the buyer of the call, now it's worth it for them to either exercise or basically you lose money because now they can exercise it, buy it at $55 and their cost is basically $55 plus $57. You will start to lose money. So what is your max profit? If the stock, if the option is exercised against you, it means the other person exercised the option. Well, guess what? They're gonna exercise at $55 or above. What's gonna happen as a result is you made $5 profit on the stock price itself plus you made $2 in premium. So that's your max profit. This is your max profit because after that, what's gonna happen is if you make profit on the stock price, your option goes down. So they kind of cancel each other. So this is your max profit. What is your max loss? What could happen to the stock? What could happen to the stock that you have? Well, what could happen to the stock? It could go down to zero. And what is your loss in case your stock went down to zero? Well, I purchased it at $50. That's how much I paid for it, but I get $2 extra. So really my net cost is $48. If the stocks goes down to zero, my max loss on this position is $48. So basically the premium kind of, the premium reduced your maximum loss by $2. I'm just asking for the maximum loss, maximum gain. What is your break even? When do you break even? Your break even basically put is $48. So your break even is right here. Why your break even is $48? It's because you paid $50. That's how much you paid initially. Then you received like a $2 refund from the premium. You got a $2 refund. Therefore your cost now is $48. So you break even at $48. And your max loss and the break even should be the same. Should be the same. So this is the break even. So simply put, we could have another line here. You break even at $48 and your gain will cap right here. So this is basically a covered call. What it does, this two extra dollars here, it gave you extra cushion, extra cushion. What do you want to happen? What you want is you want the stock price to go up like almost a 55 and stop. That's your best way. Why? Because if that's the case, they're not gonna exercise the option against you. You'll keep the $2 and your stock price will have unrealized gain. So you want the stock price to stay in this, you want the stock price to stay in this area here. Why? The option is not exercised against you. So that's good. That's good. So what you did is you reduced your cost if that happens and the exercise is not, the option is not exercised against you. So this is basically the covered call. In the prior session, we looked at the protective put and basically you make sure you understand both because in the next session, we're gonna combine those strategies. As always, I'm gonna remind you if you wanna visit my website farhatlectures.com for additional resources for this course as well as your finance and accounting courses. I like the recording, stay safe and study hard.