Suppose you short-sell a stock (which pays no dividends) for $52 and buy a $50-s

Question

Suppose you short-sell a stock (which pays no dividends) for $52 and buy a $50-strike call option for $14.25. Assuming the effective annual interest rate is 8%, what is the profit on your position if the stock is worth $44.20 when the option expires?

$–9.23

$–9.23

$–3.94

$–3.43

$11.96

$–6.45

Please explain how to get the correct answer, thank you!

Suppose you short-sell a stock (which pays no dividends) for $52 and buy a $50-strike call option for $14.25. Assuming the effective annual interest rate is 8%, what is the profit on your position if the stock is worth $44.20 when the option expires?

Selected Answer: a.

$–9.23

Answers: a.

$–9.23

b.

$–3.94

c.

$–3.43

d.

$11.96

e.

$–6.45

Please explain how to get the correct answer, thank you!

Explanation / Answer

First we shall calculate profit on short sale

Selling price less purchase price

=52-44.2

=7.8$

Now we shall calculate profit or loss on call option.

Since price at expiry is less than strike price oprtion will not be exercised. Hence premium paid = loss = 14.25$

Now we shall calculate interest received on funds received on short sales and interest paid on funds paid for premium

Total inflow of fund = 52-14.25 = 37.75$

Interest received = 37.75*8% = 3.02$

Total profit = Profirt on short sale + Interest received - loss on option

=7.8 + 3.02 - 14.25

=-3.43$

Thus ans = C) -3.43$

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