Suppose you believe that Johnson Company's stock price is going to increase from its current level...

Suppose you believe that Johnson Company's stock price is going to increase from its current level of $40 sometime during the next 5 months. For $400 you can buy a 5-month call option giving you the right to buy 100 shares at a price of $60 per share. If you buy this option for $500 and Johnson's stock price actually rises to $70, would you exercise your call option? AND what would be your pre-tax net profit or loss from holding this option?

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Expert Solution

Given Johnson Company stock price is $40

Call option brought at $500 which gives the right to buy 100 shares at $60 per share.

Given Johnson Company stock price after 5 months is $70 per share.

Let me explain how it works,

We have the right to but at $60 in the market it is $70 hence we would exercise the right and buy the stock at $60 and we can sell the same in market and get the profit of $10 per share.

Total Shares = 100

Hence total profit before considering the cost of the option is 100*10 = 10,000

When we consider the initial cost the pay off will be 10000- 500 = 9,500

jeff jeffy answered 2 years ago

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