Question

Needing Part B Assume that you have a LONG position in 25 call options with the following characteristics: Underlying stock Lionsgate (100 shares) Exercise price (X) 5.00 ($ per share) Expiration date June, 2018. At the time you purchased the call options, you paid a premium of Ct = $1.00 ($ per share). A. Given the opening trade described above, what are the three possible closing trades for your call option position? B. Assume that you have decided that your closing trade will be to offset the options. Describe what action you must take to offset the options. Be thorough.

Answer 1

Answer:

Three possible closing trades are:

• If the the call option exprires out of the money i.e. if the exercise price (X) > Stock price at time of expiry, then you'll do nothing since you'll better off by purchasing the shares from the market.
• If the the call option exprires in the money i.e. if the exercise price (X) < Stock price at time of expiry, the you shall execute the call option and will receive the differential amount {Current Stock Price ($7) - Exercise Price ($5/share)} * Number of calls (25) * Numbers of shares per call (100).
• You can take offsetting position, i.e. you are long on call option they you'll take a short position (write call options)

While opting to take an offsetting position, below are the steps:

1. The option holder will write calls options with similar features: exercise price $5/share & with similar expiry
2. Suppose at that moment call premium Ct = $2/share.
3. By executing this trade, the exchange will identify this as a cancel out trade and your position will be automatically closed.
4. Your capital gain are going to be the difference in the call premiums = C_T1 ($6)- C_T0 ($5)* Number of call options(25) * Number of shares per options (100) i.e. $2500