Suppose you think FedEx stock is going to appreciate substantially in value in t

Question

Suppose you think FedEx stock is going to appreciate substantially in value in the next 6 months. Say the stock's current price, $0, is $100, and the call option expiring in 6 months has an exercise price, X, of $100 and is selling at a price, C, of $23. With $23,000 to invest, you are considering three alternatives. a. Invest all $23,000 in the stock, buying 230 shares. b. Invest all $23,000 in 1,000 options (10 contracts). c. Buy 100 options (one contract) for $2,300, and invest the remaining $20,700 in a money market fund paying 5% in interest over 6 months (10% per year). What is your rate of return for each alternative for the following four stock prices 6 months from now?

Explanation / Answer

Answer

(1) Portfolio Value

   Price of Stock 6 months from Now

In the case of option

We assume that we invest in call option.

If Stock rate is rise from buying price we will receive difference between selling rate- strike rate. In this case ,

Strike rate of stock is $ 100.

In first case, where stock price after 6 months is $ 80, We will not make any gain or loss.

In Second case, where stock price after 6 months is $ 100, We will not make any gain or loss.

In Third case,   where stock price after 6 months is $ 110, We will gain (110-100)*1000 = $ 10000

In Fourth case,   where stock price after 6 months is $ 120, We will gain (120-100)*1000 = $ 20000

In Bills +100 option case

In Ist Case, Interset 20700*5/100= 1035. value of bills = 20700+1035 =21735 Option value is 0, So total value 21735

In IIndCase,Interset 20700*5/100= 1035. value of bills = 20700+1035 =21735 Option value is 0, So total value 21735

In IIIrdCase,Interset 20700*5/100= 1035. value of bills = 20700+1035 =21735 Option value is 1000, So total value 22735.

In IVth Case,Interset 20700*5/100= 1035. value of bills = 20700+1035 =21735 Option value is 2000, So total value 23735.

Answer- 2

Return on Portfolio

Price of Stock 6 months from Now

Working notes

In case of stock

stock value-initial investment/initial Investment *100

(1)18000-23000/23000*100 = -20%

(2)23000-23000/23000*100 = 0%

(3)25300-23000/23000*100 = 10%

(4)27600-23000/23000*100 = 20%

In case of option

value of option stock -initial investment/initial Investment *100

(1)0-23000/23000*100 = 100%

(2)0-23000/23000*100 = 100%

(3)1000-23000/23000*100 = -56%

(4)20000-23000/23000*100 = -13%

In case of Bill +Options

value of investment -initial investment/initial Investment *100

(1) 21735-23000/23000*100 = -5.5%

(2)21735-23000/23000*100 = -5.5%

(3)22735-23000/23000*100 = -1.15%

(4)23735-23000/23000*100 = 3.20%

Stock Price $ 80 $ 100 $110 $120 All stocks (230 Shares) 18400 23000 25300 27600 All options (1000 Options) 0 0 10000 20000 Bills +100 Options 21735 21735 22735 23735

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