So far, things have gone well with Dr. Washington Before you wrap up your meetin

Question

So far, things have gone well with Dr. Washington Before you wrap up your meetings and he begins investing, you decide to spend a little time sharing information with him about using derivatives to manage risk and enhance returns in his stock portfolio .You decide the best way to illustrate this is via a call option that he can use on a stock that might have some upside potential If the stock does not reach the potential, the option minimizes the risk The stock is AXQ Enterprises-a high-tech firm that did well during the Internet boom but declined when the boom turned into a bust. If the company's new portal software is adopted by a large number of consumers over the next few months, you believe the stock can go much higher The 6-month options are priced at U$S1, the strike price is US$22. and the current price for AXQ stock is US$20.Put together a PowerPoint presentation with a table or graph included that illustrates what advice you would give Dr. Washington on the options if the price of the stock was US$18. US$21. USS24. or U$S28 at the end of 6 months. Assignment Guidelines: Create a PowerPoint presentation for Dr Washington that includes the following: Slide 1 - Title Slide (Name, course name, and unit number) slide 2 - Your table or graph that contains the stock option data and the profit loss depending on the stock prices of US$18. US$21. US$24. or US$28 at the end of the 6-month period. Slide 3 - Your recommendations on whether or not to exercise the option based on the four hypothetical stock prices from slide 2 Explain the reasoning behind your recommendations. Slide 4 - Answer the following question: What happens if the stock price hits US$23? U$S23.01? Slide 5 - Answer the following question What purpose could adding a technology company into a stock portfolio serve?

Explanation / Answer

A call option is a piece of paper that gives you the right to buy stock at a given price up until the expiration date. The advantage of buying them compared to buying stock is leverage; if the stock goes up you can make more money. The disadvantage is that time is against you. If they expire you lose everything, whereas if you bought the stock you'd still have it. In the example here, if the stock closes above $22 after six month the option will have some value. If it closes at 24, the option will be worth 2 (keep in mind you paid 1 for it). If the stock closes at 28, the option will be worth 6. For you to actually make a profit, the stock must close at $23.01 or higher -- since a 23 close makes the option worth 1, exactly what you paid for it.

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