Question

Suppose you think Wal-Mart stock is going to appreciate in the next year. Current price is $100, and the call option expiring in one year has an exercise price, X, of $100 and is selling at a price, C, of $10. With $10,000 to invest, you invest all in 1,000 options (10 contracts). Alternatively, you can invest all in the stock. What is the rate of return for each alternative if one year later the stock price is $120?

Answer 1

Answer:

the rate of return for each alternative if one year later the stock price is $120 is 100% and 20%

Explanation:

Price of buying call option = 10*1000 = 10000

After 1 year the person can reverse the trade and get profit without having to buy the stock.

Hence profit = 120-100 = 20

Minus call price = 10

Profit per each share = 10

On 1000 shares = 10,000

Hence profit = 10,000/10,000 = 100%

In case we buy stock:

Price of stock = 100*1000 = 100,000

Profit on one stock = 120-100 = 20

On 1000 stock = 20,000

Profit = 20,000/100,000 = 20%

Therefore,the rate of return for each alternative if one year later the stock price is $120 is 100% and 20%