72 ) MGT 2100 - Final Review- You are expecting the current stock price to incre
ID: 1171217 • Letter: 7
Question
72 ) MGT 2100 - Final Review- You are expecting the current stock price to increase in the near future. The stock currently trades for $23 per SH. A call option with a price (strike price) of $25 can be purchased for $4.60 per share at this particular time. You have $4,600 to invest.
a) What are your two alternative investment strategies for the $4,600 (one in the stock and the other in call options)? Assume all of this money must be invested in either stock or options for this question.
b) What will your profit ($) for the stock strategy be if the price of the stock on the expiration date is $31 per share?
c) What will your profit ($) to the option strategy be if the price of the stock on the expiration date is $31 per share?
d) What underlying asset price do you break even on the option strategy?
Explanation / Answer
Here,
Current stock price= $23
Call option strike price= $25
Call premium = $4.60
a) The two investment strategies for the $4600 are
i) Buy the stock at $23 per share
ii) Buy call option at $4.60 per call option
b) Profit for stock strategy
Amount of share bought =Amount to be invested/Purchase price
= $4,600/23= 200 shares
Profit on stock strategy
=( Price on expiration-Purchase price)*No of shares
=(31-23)*200
=$1,600
c) Profit on option strategy
=(Price of share on expiration-strike price-premium paid)*Number of options
= (31-25-4.60)*(4600/4.60)
=$1400
d) The underlying asset breakeven price= strike price+ premium paid
=$25+$4.60
=$29.60
Please feel free to ask if you have any query in the comment section.
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