Question

You are bullish on Amazon and want to compare 3-month strategies of buying stock to buying call options. Currently Amazon stock is priced S0 = 2900, and 3-month call options with K=3000 cost c0 = 29 (per share). You have $2.9M to invest, so you can buy 1000 shares or go long calls on 100,000 shares. i] How much does AMZN need to increase over the 3-month period so that the calls are the better investment? ii] What is the risk of calls versus shares?

Answer 1

Deatils given in question as follows:

Amazon stock price $2900 , K = $3000, Premium or Cost of Call = $29 (Per Share), Investment amount $2.9 m

If an investor long call on 100,000 shares than outflow per share would be cost of call option i.e.; $29 per share

Strike price of the call option X = $3000

Total cost for the investor is $3000 + $ 29 = $3029 if stock price of Amazon moves above $3029 than it would be better investment for investor other wise there would be loss of premium as follows:

Case Stock Price (SP) after 3 months X Price Premium Total Cost (TC) NP (SP-TC )

Case 1 $3000 $3000 $29 $3029 -$29

Case 2 $3015 $3000 $29 $3029 -$14

Case 3 $3100 $3000 $29 $3029 $71

Risk in Investing call option:

Risk in investing call option are more as compared to stock due to following reason:

a. If call option does not excersice than entire premium of call option is wiped out. In the above example if stock price after 3 months if Amazon does not cross $3000 than entire premium would be lost by investor.

b. In stock you can take delivery and hold the same but in call option it expire after particular time say in the above example after 3 months if call option not turn out to be In the money (means profitable to investor) than entire premium wiped out and loss for the investor.

Call options are more risky as compared to stock investment