Question

X Stock is currently trading for $32.80. If its January $35.00 strike call option has a $1.50 premium and you want to sell 5 contracts, briefly explain what that entitles or potentially requires you to do. Is the contract in or out-of-the-money? Also, what would your dollar maximum gain, maximum loss, and break-even price (market price) be with this strategy (assume you don’t own HDS…and you hold the contract to expiration)? Last, briefly explain why this $1.50 premium is relative low when compared to another stock in same industry that has a January call option ~ $3 out-of-the-money selling at a $2.80 premium.

Answer 1

If I need to sell call options, then I am betting on the downside of the stock and I will be selling the the strike price of $35 January call option.

There will be a total inflow of (1.5*5)= $7.5 in my trading account as I have sold the call options.

That will be requiring me to have adequate margin in my account to sell this contract and when I have sold this contract I will be having an obligation to square off my position with the call option buyer before the maturity and if the contract is expiring below the exercise price the entire premium is my gain because it cannot be exercised by the call buyer.

This contract is out of the money as strike price has not been crossed by the current market price and my maximum gain will be entire premium which I have received and my maximum loss will be unlimited because the share price can go up to unlimited extent.

This call option can be lowered due to the ability of lower volatility of the company in respect to the market and another is stock may have higher market price which will be meaning in even the out of the money put options will be higher-priced because there number of units in contract will be lower.