Question

If you are bullish about stock T, discuss and appraise whether each of the following strategies is appropriate for yielding the greatest return if you are correct.

Strategy A: Buy stock T

Strategy B: Buy call options on stock T

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Answer 1

Strategy A :

Buying a stock when anticipating a bullish market is a appropriate action. Because when we want to make profits, we need to buy at low and sell at high. Since we are bullish, we are anticipating that the price of stock T will increase in future. Since the price will be low at present when compared to the anticpated bullish price at a future point of time, it is advisable to buy the stock now and hold to make profits.

Strategy B :

Buying call option gives a right to purchase the underlying stock at a agreed time. Since we are anticipating that the stock price increases and the anticipations may not go correct all the time, there are chances that we might end up making losses if our anticipations go wrong.

But with the call options we are at a advantage that we can exercise the option only if our ancipation goes correct. If the price of T decreases then we choose to lapse the contract so that we can avoid facing losses. But in any case we need a nominal amount as premium.