Original Question The price of a stock is $100. A three-month call option with a
ID: 2634009 • Letter: O
Question
Original Question
The price of a stock is $100. A three-month call option with a strike price of $101 sells for $5.00. An investor is trying to decide between buying 100 shares and buying 20 call options contracts. Both alternatives require an investment of $10.000 Suppose the stock price in three months may vary and follows a uniform distribution between $90 and $110. Please help the investor choose the best alternative based on the EMV.
So far a guy answered this question to a point(Chegg Solution which I guess it is not completed or wrong):
http://www.chegg.com/homework-help/questions-and-answers/price-stock-100-three-month-call-option-strike-price-101-sells-500-investor-trying-decide--q6183585
@Suresh Reddy
Soln: Investment option 1
Buy 100 stocks at the price of $ 100 = $ 10,000
Suppose the stock value is $90 at end of 3 months the ending market value will be = $9,000
The buyer of the stock has incurred lossof $ 1,000
Suppose the value of stock is 110 then ending market value will be 11,000 and buyer of the stock has made profit of $ 1000.
Investment option 2:
Purchase a 3 month call option for a strike price of $101.
Price of call option = $ 5
Money invested in call option = $ 100
Suppose after 3 months the price of the stock is $90 then the investment will not be made and the person looses $ 100 only.
Suppose the price of the stock is 110 then the person will exercise the call option and buy 100 stocks at the strike price of $ 101.
The ending market value will be $11,000 - $10,100
Explanation / Answer
Scenario Analysis
Mean return of all scenario for investment in option is negative which makes investmnet in stock as better option
Stock price closing Profit(Invsetment in stock)100*(closing-100) Profit(Investment in Option)
-100+20*Max(0,Closing-101) 90 -1000 -100 91 -900 -100 92 -800 -100 93 -700 -100 94 -600 -100 95 -500 -100 96 -400 -100 97 -300 -100 98 -200 -100 99 -100 -100 100 0 -100 101 100 -100 102 200 -80 103 300 -60 104 400 -40 105 500 -20 106 600 0 107 700 20 108 800 40 109 900 60 110 1000 80 Mean 0 -57.14285714
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