Question

Illustrate a long stock and long call position with example. Build a table and diagram to relate your explanation. (10 marks)

Answer 1

Explanation

Call option is the right to buy a stock at the exercise price for the certain amount of premium expiring at particular time t . Initial investment on long call position is very low as compared to be long on stock therefore percentage return on investment on long call can be huge.

When the price of the underlying security moves down significantly till the expiration date of the option, there is a loss on the long stock position but the long call position incurs a 100% loss as it expires worthless. In absolute terms, the long call position may experience a smaller loss than that loss incurred by a long stock strategy that is equal to the premium paid.

Call options’ breakeven point is higher than the current stock price because of the extrinsic value (also known as time value, and measured by the option greek theta) associated with a call option, especially when it comes to an expiration date

Call option can be used to buy the stock at expiry by paying the exercise price of stock