Question

we consider an investor with $5,000 to invest. Assume the spot price in 12 months is $100. Calculate the amount the investor will make spending the $5,000 to buy shares of stock, spending the $5,000 to buy puts with a strike of $100, or spending the $5,000 to buy calls with a strike of $100? Based on this analysis, Why do investors use options? what is the advantage of using options?

Answer 1

Answer:

If buying stock-

If a stock is trading at $100 and an Investor has $5000, He will buy 50 shares only

Number of shares bought = Investment amount / Price of the stock

Number of shares bought: 5000/100 = 50 shares

If buying Options (Call/Put)

When options is bought, buyer of the option has to pay upfront premium that is the price of the option.

If strike price is $100 and premium of Call option is $20 then options contract that can be bought are:

Investment amount / Price of options

5000/20 = 250 Call contracts

Why do investors use options?

Answer: Investors use options because options have imited risk and unlimited potential, they are bought and sold for hedging and profit making purpose.

What is the advantage of using options?

Answer: Advantages of using option- Are as following:

• Options can be bought with less amount also so they do not require much investment,
• They are cost effective.
• They are less risky then equities because Buyer of an options has limited risk that is maximum to the extent of premum paid by him.
• They are used for different trading strategies that are further used for hedging purpose.