Question Completion Status The current price of a stock is $40, and two-month Eu

Question

Question Completion Status The current price of a stock is $40, and two-month European call options with a strike price of $43 investor who feels that the price of the stock will increase is trying to decide between two buying 800 call options (8 contracts). Both strategies involve an investment of $4,000 a. Which strategy will earn more profits if the stock increases to $42? b. How high does the stock price have to rise for the option strategy to be more profitable? currently sell for $5. An strategies: buying 100 shares or Please choose all correct answers. Please note that each incorrect answer will reduce the score by 10%. 1If the stock closes at $42, buying100 shares will have a profit of $200 and buying 800 callswill have a loss of $3,000. So buying stocks will be better than buying options 2.The option strategy is more profitable if the stock price rises above $43.45 3. If the stock closes at $42, buying100 shares will have a profit of $200 and buying 800 calls will have a loss of $4,000. So buying stocks wl be better than buying options 4. The option strategy is more profitable if the stock price goes below 54794 5. The option strategy is more profitable if the stock price rises above $49.14 6. If the stock closes at $42, buying100 shares will have a profit of $200 and buying 800 calls will have a loss of $2.000. So buying stocks will be better than buying options 7. If the stock closes at $42, buying100 shares will have a profit of $200 and buying 8000 calls wil have a profit of $2000. So buying call options wil be better than buying stocks 8. The option strategy is more profitable if the stock price rises above $45.78 5 8

Explanation / Answer

Solution:

Current price of the stock = $40

Strategy 1: Buying the stock

If we buy this stock and price goes more than $40 then we will make profit, and when the price goes below $40 then we will bear loss.

So we buy 100 stocks @ 40. Total investment = $4000

Strategy 2: Buying the call option

If we buy the call option then call option can be exercised when the price of the stock goes above the strike price.

We also pay premium for buying the call option so this becomes profitable when the

Stock price > Strike price+ premium paid

In this case, Srtrike price is $43 and premium paid is $5,

So share price should be more than $43 +$5 = $48 to become profitable

We buy 800 call option @5 , Investment = 800 *5 = 4000

Given that share price goes to $42 only

Strategy 1: We purchased at $40 and current price is $42. So, we will make profit of $2 per share. We had purchased 100 shares so profit = 100*2 = $200

Strategy 2: This option is worthless because share price (42) is below the strike price of 43. So we loose our investment of $4000

Correct answers

Option 3 is correct. Becasue we are gaining $200 when we buy shares and option contract will give us loss of $4000.

Option 5 is correct.

When share price rises above $49.14 then lets assume share price is 49.15 then profit from one share = $49.15-40 = 9.15

Total profit = 100 share * 9.15 = 915

Profit from one option = 49.15 - 48 = 1.15

We have 800, so total profit = 800*1.15 = 920

If share price is 49.15 and more then option contract is more profitable

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