Question

Cisco stock price is $20 per share now. Investor A expects the stock price to go up because of the 5G technology breakthrough. With $10,000 available, investor A will choose from the following alternative investment strategies to make profit from the price change.

1) He will invest all the money buying Cisco stocks at the current price $20. In one month, if the stock price of Cisco increases to $25, what is his total dollar amount profit? (4 points)

2) Instead, he will invest all the money buying call option of Cisco stock at a premium of C=$1.5 per share with strike price $19 and one month maturity. In one month, if the stock price of Cisco increases to $25, what is his total dollar amount profit / loss? (4 points)

3) Instead, he will write 10,000 put options on Cisco stock at a premium of P=$0.5 per share with strike price of $20 and one month maturity date. In one month, if the stock price of Cisco increases to $25, what would be his total dollar amount profit / loss? (4 points)

4) Investor A did exactly the same transactions as above, but stock price of Cisco drops to $5 at the end of the month because of unexpected CEO’s scandal. Recalculate the dollar amount of profit/loss of Investor A under all the previousthree different investment strategies. (5 points)

Answer 1

1.Total profit under Ist strategy

No. of shares A purchases=$10,000/$20

=500 shares

Total Profit=(Stock price at the end of the month-Stock Purchase price)*No. of stock

=($25-$20)*500

=$2,500

2.Call premium Per shares=$1.5

Breakeven Stock price =Call option strike price+Premium paid

=$19+$1.5

=$20.5

Profit=Stock Price at Expiration-Breakeven Stock price

=$25-$20.5

=$4.5

3.In the given transaction,no one will be excercise the put option,since stock price is higher than the strike price.Thus total Profit will be total premium received.

Total profit=10,000*$0.5

=$5,000

4.Calculation of total profit or (loss)

Transaction 1

Total Profit/(Loss)=(Stock price at the end of the month-Stock Purchase price)*No. of stock

=($5-$20)*500

=($7500)

Transaction 2

Since the stock price($5) is lower than the strike price($19),hence Investor A would not excercise the option.Therefore Total loss to the Investor is the total premium paid.

Total Loss=Total Premium Paid

=$10,000

Transaction 3

Total Loss=[Premium Received-(strike Price-stock price at the end)]*No. of Option

=[$.5-($20-$5)]*10,000

=$145,000