Question 19 Sainsbury\'s shares are currently priced in October 2018 at 450 penc

Question

Question 19 Sainsbury's shares are currently priced in October 2018 at 450 pence a share. You believe that they are currently considerably undervalued and are worth 600 pence a share. December 2018 call options on a strike price of 520 pence a share are currently valued at 35 pence. Each call option contract is based on 1000 shares. (a) What is the total premium in pounds that is paid for each call option contract? [1] (b) What is the net profit (+)/net loss ( in pounds to the holder if the shares are priced at 600 pence in December 2018 ? [1.5] (c) What is the net profit (+) net loss (-) in pounds to the holder if the shares are priced at 500 pence in December 2018 ? [1.5] d) What is the maximum profit in pounds that can be made by the writer of the call option? [1]

Explanation / Answer

(a) Total premium paid =1000 x 35 = 35000 pence = 350 pound

(b) profit = (600-520) x 1000 - 35000 = 80000 -35000 = 45000 pence = 450 pound

(c) The price is below 520 pence, so he will not exercise his call option, so loss will be there, which is equal to premium paid = 350 pound

(d) writer of call option has limited profit which is equal to premium paid by the buyer of call option

so amximum profit = premium paid by buyer of call option = 350 pound

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