Suppose you have $55,000 to invest. You\'re considering Miller-Moore Equine Ente

Question

Suppose you have $55,000 to invest. You're considering Miller-Moore Equine Enterprises (MMEE), which is currently selling for $110 per share. You also notice that a call option with a $110 strike price and six months to maturity is available. The premium is $5.5. MMEE pays no dividends. What is your annualized return from these two investments if, in six months, MMEE is selling for $118 per share What about $106 per share

Explanation / Answer

Solution : Annualized return = {[(Income + (End of Period Value – Initial Value)] / Initial Value+ 1}1/t – 1 Note: As there is no dividend so income will be zero (A) For stock : (i) If price at T-6 is 118 [{( 0 + 118 - 110)/110} + 1] ^ 1/0.5   - 1 (here 1/0.5 is due to 6 month tenure and it will be 2) [1.0727] ^ 2 - 1 15.07% (ii) If price at T-6 is 106 [{( 0 + 106 - 110)/110} + 1] ^ 1/0.5   - 1 [0.9636] ^ 2 - 1 (-) 7.14% (B) For option : (i) If price at T-6 is 118 Note : 1. As price at T-6 > Stike price so option is to be exercised. 2. here net gain is calculated only. 3. premium is also be deducted for calculating return [{( 0 + 118 - 110 - 5.5 )/5.5 } + 1] ^ 1/0.5   - 1 [1.45] ^ 2 - 1 111.57% (ii) If price at T-6 is 106 1. As price at T-6 Stike price so option is to be exercised. 2. here net gain is calculated only. 3. premium is also be deducted for calculating return [( 0 + 118 - 110 - 5.5 )/5.5 ] * 2 [0.4545] * 2 90.91% (ii) If price at T-6 is 106 1. As price at T-6 Stike price so option is to be exercised. 2. here net gain is calculated only. 3. premium is also be deducted for calculating return [{( 0 + 118 - 110 - 5.5 )/5.5 } + 1] ^ 1/0.5   - 1 [1.45] ^ 2 - 1 111.57% (ii) If price at T-6 is 106 1. As price at T-6 Stike price so option is to be exercised. 2. here net gain is calculated only. 3. premium is also be deducted for calculating return [( 0 + 118 - 110 - 5.5 )/5.5 ] * 2 [0.4545] * 2 90.91% (ii) If price at T-6 is 106 1. As price at T-6

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