Ted Westfall was considering the purchase of 100 shares of Stopgap Corporation c
ID: 2752362 • Letter: T
Question
Ted Westfall was considering the purchase of 100 shares of Stopgap Corporation common stock selling at $32.40 per share on the last day in October. As an alternative, Len Griffen, Ted’s neighbor, suggested that Ted consider a Stopgap option instead. Together they examined the following information that was obtained from their broker.
Exercise
Price Calls Puts
30 6 2
35 3.50 4.75
What are Ted’s profits and rates of return if he makes the following purchases and subsequently closes his position at expiration given the stock prices as indicated below?
a. A call with an exercise price of 30. The stock ends up at 41.90.
b. A call with an exercise price of 35. The stock ends up at 33.
c. A put with an exercise price of 30. The stock ends up at 37.
d. A put with an exercise price of 35. The stock ends up at 29.
Explanation / Answer
(a) Cost of purchasing a call with strike $30 = $6
Stock price on expiry = $41.90
Value of call on expiry = $41.90 - $30 = $11.90
Total Profit = Value of Call - Premium paid = $11.90 - $6 = $5.90
(b) Cost of purchasing call with strike $35 = $3.50
Stock price on expiry = $33
Value of Call on expiry = $0 (it will expire worthless)
Total Loss = Premium Paid = $3.50
c) Cost of purchasing put with strike $30 = $2
Stock price on expiry = $37
Value of Put on expiry = $0 (it will expire worthless)
Total Loss = Premium Paid = $2
(d) Cost of put option with strike $35 = $4.75
Stock price on expiry = $29
Value of put on expiry = $35 - $29 = $6
Total Profit = Value of Put on expiry - Premium Paid = $6 - $4.75 = $1.25
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