Question

Suppose a stock is priced at $ 40 at expiry and the annual interest rate is 12 %. Determine the profit at expiry for the following one-year European call options:

a)A $ 35-strike call with premium $ 9.94

b)A $ 45-strike call with premium $ 4.73

Answer 1

Stock price at expiry = $40

We need to calculate profit at expiry, so he will calculate the future value of premiums paid on call

a) Value of option at expiry= max [(stock price - strike price),0]

Value of option at expiry = max [(40-35),0]

Value of option at expiry = 5

Profit / (loss) on option at expiry = value of option on expiry - future value of premium

Profit / (loss) on option at expiry = 5 - 9.94*(1+12%)

Profit / (loss) on option at expiry = 5 - 11.13

Therefore (loss) on option = ($ 6.13)

b) Value of option at expiry= max [(stock price - strike price),0]

Value of option at expiry = max [(40-45),0]

Value of option at expiry = 0

Profit / (loss) on option at expiry = value of option on expiry - future value of premium

Profit / (loss) on option at expiry = 0 - 4.73 *(1+12%)

Profit / (loss) on option at expiry = 5.30

Therefore (loss) on option = ($ 5.30)

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