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16

16.A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above

A.$45

B.$46

C.$55

D.$50

A.$45

B.$46

C.$55

D.$50

Answer: D

When the stock price is $50 the first alternative leads to a position in the stock worth 100×50 or $5000. The second alternative leads to a payoff from the options of 1000×(50−45) or $5000. Both alternatives cost $4000. It follows that the alternatives are equally profitable when the stock price is $50. For stock prices above $50 the option alternative is more profitable.

When the stock price is $50 the first alternative leads to a position in the stock worth 100×50 or $5000. The second alternative leads to a payoff from the options of 1000×(50−45) or $5000. Both alternatives cost $4000. It follows that the alternatives are equally profitable when the stock price is $50. For stock prices above $50 the option alternative is more profitable.

Flashcard info:

Author: CoboCards-User

Main topic: Finance & Investment

Topic: Derivatives

Published: 27.10.2015