1215

Suppose the price of a share of Stock A is $100. A European call option that matures one month from now has a premium of $8, and an exercise price of $100. Ignoring commissions and the time value of money, the holder of the call option will earn a profit if the price of the share one month from now:

A) decreases to $90.

B) increases to $106.

C) increases to $110.

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The breakeven point is the strike price plus the premium, or $100 + $8 = $108. Any price greater than this would result in a profit, and the only choice that exceeds this amount is $110.

1215

A stock is trading at $18 per share. An investor believes that the stock will move either up or down. He buys a call option on the stock with an exercise price of $20. He also buys two put options on the same stock each with an exercise price of $25. The call option costs $2 and the put options cost $9 each. The stock falls to $17 per share at the expiration date and the investor closes his entire position. The investor’s net gain or loss is:

A) $4 gain.

B) $4 loss.

C) $3 loss.

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The total cost of the options is $2 + ($9 × 2) = $20.

>At expiration, the call is worth Max [0, 17-20] = 0.  Each put is worth Max [0, 25-17] = $8.  The investor made $16 on the puts but spent $20 to buy the three options, for a net loss of $4.

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