Question

Devon Energy stock is currently trading at $15 per share. You expect the stock to increase to $35 in the next 6 months. If you choose to speculate on your belief, which of the following positions will provide the greatest profit if you hold it for the entire 6 months

A long 6-month futures contract trading at $15.15

A long put option expiring in 6 months with a strike price of 15 and a put premium of $1.15

A long call option expiring in 6 months with a strike price of 15 and a call premium of $1.15

A short 6-month futures contract trading at $15.15

Answer 1

Answer: Option (1) A long 6-month futures contract at $15.15

By entering a long 6-month futures contract at $15.15, we must buy the Devon Energy Stock after 6 months at $ 15.15, irrespective on actual price at that time. As we are expecting the stock to increase to $ 35 in next 6 Months, it is better to enter into this futures contract.

Profit under this Option will be ($35 - $ 15.15) = $ 19.85 per Share.

Other Options:

* By entering a short 6-month futures contract at $15.15, we must sell the Devon Energy Stock after 6 months at $ 15.15, irrespective on actual price at that time. As we are expecting the stock to increase to $ 35 in next 6 Months, it is not advisable to enter into this futures contract.

* By entering a long Call Option expiring in 6-months with a strike price of $15.15 by paying a premium of $ 1.5, we will have the option to buy the Devon Energy Stock after 6 months at $ 15.15, if the actual price at that time is lessthan Striike Price. As we are expecting the stock to increase to $ 35 in next 6 Months, it is also advisable to buy this long Call, but the profit will be less than under Futures Option as we have to pay Premium for buying this Option.

Profit under this Option will be ($35 - $ 15.15) - $ 1.5 premium = $ 18.35 per Share.

* By entering a long Put Option expiring in 6-months with a strike price of $15.15 by paying a premium of $ 1.5, we will have the option to sell the Devon Energy Stock after 6 months at $ 15.15, if the actual price at that time is greaterthan Striike Price. As we are expecting the stock to increase to $ 35 in next 6 Months, it is not advisable to buy this long Put. As we will always prefer to sell at a higher Price prevailing in the market.