1.) Information about questions: ABC stock runs from 36-41 on big news. 1a) It i
ID: 2813086 • Letter: 1
Question
1.) Information about questions: ABC stock runs from 36-41 on big news.
1a) It is December 18, and the ABC Jan 40 calls are now trading at $2.30. Is this option likely to be exercised now? Explain
2b) If eight of these options were originally purchased at $.85 less than one month ago, and are now sold at the current price, what is the tax liability thus created from this trade?
3c)If four of these options were originally sold at $.85 against 400 shares of stock and the stock is called away in January at the strike price, what is the tax liability to the seller?
Note: This was all the information I was given.
Explanation / Answer
a) Strike price of the stock is 40 and stock is currently trading at 40, so obviously, the call is in the money and it is likely to get exercised but it also depends upon what was the premuim paid by the investor when he / she have bought the call
Pay out of option is = S - K - C
S is the stock price
K is the strike price
C is the option premium
So in our example, if premium is less than 1 per call option then investor should exercise
b) Call premium = 0.85
Number of option bought = 8
Total cost = 8 * 0.85 = 6.5
Current call premium = 2.30
Total price = 2.30 * 8 = 18.4
So Total profit = 18.4 - 6.5 =11.9
This will become your short term capital gain since it is only been a month and this gain will be taxed. Tax liability will depend upon the tax % which will be levied on the short term capital gain
c) Number of options sold = 4
Price = 0.85
Number of shares = 400
Total price you have got when sold = 400 * 0.85 * 4 = 343.36
Now since the share is called away at the strike price, it will not get exercised and the amount which you have recieved will become your profit. So 343.36 will become your gain and it will be taxed.
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