1. You are looking at a stock priced at $30 per share that you expect to increas
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Question
1. You are looking at a stock priced at $30 per share that you expect to increase in value over the next year. A call option on this stock with exercise price = $35 and a maturity of one year is selling for $6. With $6,000 to invest, you are considering three alternatives:
i. Invest all $6,000 in the stock
ii. Invest all $6,000 in options
iii. Buy 200 options and invest the remaining funds in a money market fund earning 1%
(a) Construct a table showing your rate of return for each alternative investment if the stock price is 10, 15, 20, 25, 30, 35, 40, 45, 50, 55, 60 one year from now.
Explanation / Answer
Option 1: Number of shares bought = 6000/30 = 200
Option 2: Number of options bought = 6000/6 = 1000
Option 3: 200 options + $4800 in MMF at 1%
Stock Price
Option 1 Return
Option 2 Return
Option 3 Return
10
-66.7%
-100.0%
-19.2%
15
-50.0%
-100.0%
-19.2%
20
-33.3%
-100.0%
-19.2%
25
-16.7%
-100.0%
-19.2%
30
0.0%
-100.0%
-19.2%
35
16.7%
-100.0%
-19.2%
40
33.3%
-16.7%
-2.5%
45
50.0%
66.7%
14.1%
50
66.7%
150.0%
30.8%
55
83.3%
233.3%
47.5%
60
100.0%
316.7%
64.1%
Stock Price
Option 1 Return
Option 2 Return
Option 3 Return
10
-66.7%
-100.0%
-19.2%
15
-50.0%
-100.0%
-19.2%
20
-33.3%
-100.0%
-19.2%
25
-16.7%
-100.0%
-19.2%
30
0.0%
-100.0%
-19.2%
35
16.7%
-100.0%
-19.2%
40
33.3%
-16.7%
-2.5%
45
50.0%
66.7%
14.1%
50
66.7%
150.0%
30.8%
55
83.3%
233.3%
47.5%
60
100.0%
316.7%
64.1%
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