Question

Assume you purchase 200 shares of Apple at $350 per share, but you are worried that it may fall in price, so you wish to hedge part of your position by writing a 100 share option. The option has a strike price of $300 and a premium of $50. If at that the time of expiration, the stock is selling at the following prices ($200, $300, $400) what will be your overall gain or loss? What about the person who bought the option from you?

Answer 1

Assume you purchase 200 shares of Apple at $350 per share, but you are worried that it may fall in price, so you wish to hedge part of your position by writing a 100 share option. The option has a strike price of $300 and a premium of $50. If at that the time of expiration, the stock is selling at the following prices ($200, $300, $400) what will be your overall gain or loss? What about the person who bought the option from you?

Purchase Price of Apple Share (P) = 350

Quantity (N) = 200 Shares

Now To hedge Against expected fall of Position in Securities One should Write Call Option.

Strike Price of the Call Option X = 300

Quantity (Q) = 100

Call Premium (c) = 50

When writing a Call Option Premium will be received.

Maturity Stock Price P1

Scenario 01 : Maturity Stock Price P1 = 200

Profit from the Stock Position = N * ( P1 - P) = 200* ( 200 - 350) = 200*(- 150 ) = -30,000

Since Maturity Price P1 is less than Strike Price So call Option will expire.

Profit from the Call Option = Total Premiumreceived = Q * c = 100 * 50 = 5000

Overall Loss = Profit from the Stock Position + Profit from the Call Option = - 30,000 + 5000 = -25,000 (Ans)

Scenario 02 : Maturity Stock Price P1 = 300

Profit from the Stock Position = N * ( P1 - P) = 200* ( 300 - 350) = 200*(- 50 ) = -10,000

Since Maturity Price P1 is equal to Strike Price So call Option will expire.

Profit from the Call Option = Total Premiumreceived = Q * c = 100 * 50 = 5000

Overall Loss = Profit from the Stock Position + Profit from the Call Option = - 10,000 + 5000 = -5,000 (Ans)

Scenario 03 : Maturity Stock Price P1 = 400

Profit from the Stock Position = N * ( P1 - P) = 200* ( 400 - 350) = 200* 50 = 10,000

Since Maturity Price P1 is higher than Strike Price So buyer will claim the call option at maturity.

Loss from Call Option at Maturity = Q* ( P1 - Strike Price) = 100 * ( 400 - 300) = 10,000

Profit from the Call Option = Total Premiumreceived - Loss from Call Option at Maturity = Q * c - Loss from Call Option at Maturity = 100 * 50   - 10000= -5000

Overall Loss = Profit from the Stock Position + Profit from the Call Option = 10,000 - 5000 = 5,000 (Ans)