Both a call and a put currently are traded on stock XYZ; both have strike prices
ID: 2625839 • Letter: B
Question
Both a call and a put currently are traded on stock XYZ; both have strike prices of $45 and expirations of 6 months.
a. What will be the profit to an investor who buys the call for $5 in the following scenarios for stock prices in 6 months? (a) $40; (b) $45; (c) $50; (d) $55; (e) $60. (Negative amounts should be indicated by a minus sign. Round your answers to 1 decimal place. Omit the "$" sign in your response.)
b. What will be the profit to an investor who buys the put for $7.5 in the following scenarios for stock prices in 6 months? (a) $40; (b) $45; (c) $50; (d) $55; (e) $60. (Negative amounts should be indicated by a minus sign. Round your answers to 1 decimal place. Omit the "$" sign in your response.)
If you could give step by step instructions that would be great.....Thanks!
Explanation / Answer
A call option gives you the right to you the right to buy at the pre determined strike price irrespective of the prevailing price. So a strike price of $45 means that you can buy the stocks upon expiry at $45.
A put option on the other hand gives you the right to sell at the strike price.
So if the price is say $100 then you will get to buy th option for $45 meaning that you have $55 - cost of buying option as your profit.
Here in the following case your cost of buying the option is $5 + $5 = $10; one for call, one for put.
For te first case when the price is (a) $40;
Obvioulsy you won't exercise your call option to buy at $45 as the you can buy the same from the open market at $40.
As for the put option you will exercise it so that you get a profit of $5 for that transaction.
Net profit= $5 - $10 = -5
(b) $45 indifferent towards exercising either options as the market price is the same as the strike price. So there will be nothing to gain from exercising these options
Net profit = -10
(c) $50; Exercise call option. Profit from transaction =50-45=5
Put option unused as the strike price of selling is lower than the market price. By selling for a lower price you will face losses.
Net profit = 5-10=-5
(d) $55 Exercise call option. Profit from transaction =55-45=10
Put option unused
Net profit = 10-10=0
(e) $60
Exercise call option. Profit from transaction =60-45=15
Put option unused
Net profit = 15-10=5
similarly for the second case when the premium is $7.5 for each option. the cost of buying options becomes $15. I am writing the final figures and hope that you calculate them to practice abit. feel free to ask for any assistance.
a) $40
Net profit = -10
b) $45
Net profit = -15
c) $50
Net profit = -10
d) $55
Net profit = -5
e) $45
Net profit = -0
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