Question

Suppose that you purchased a call option with a strike price of $30 and paid a premium of $6.

2a) What is your payoff if the price of the stock at expiration is $10?

• -$6
• -$20
• $0
• None of the above

2b) What is your profit if the price of the stock at expiration is $10?

• -$6
• -$20
• $0
• None of the above

2c) What is your payoff if the price of the stock at expiration is $70?

• $0
• $34
• $40
• None of the above

2d) What is your profit if the price of the stock at expiration is $70?

• $0
• $34
• $40
• None of the above

Now assume that instead of buying the call option, you wrote the call option.

2e) What is your payoff if the price of the stock at expiration is $10?

• -$6
• $0
• $6
• None of the above

2f) What is your profit if the price of the stock at expiration is $10?

• -$6
• $0
• $6
• None of the above

2g) What is your payoff if the price of the stock at expiration is $70?

• -$40
• -$34
• $0
• None of the above

2h) What is your profit if the price of the stock at expiration is $70?

• -$40
• -$34
• $0
• None of the above

Answer 1

2a-d) The long will exercise the call option when the spot price is higher than the strike price. If strike price is lower than the spot price, the option will not be exercised. Profit = payoff - premium

Strike Price	Spot price	Payoff	Profit
30	10	0	-6
30	70	40	34

When the spot price is 10 then the long party will not exercise option and therefore his payoff will be equal to 0 The premium that the long pays goes wasted and therefore his profit is 0-6 = -6 which is negative and therefore a loss

When the spot price is 70 then the long party will exercise option and therefore his payoff will be equal to spot-strike, 70-30 = 40. The premium that the long pays reduces the profit and therefore his profit is 40-6 = 34

2e-h) The short is the seller of the option. He pockets premium when the option is not exercised but when the spot is 70, then the payoff and profit are just the negative of that of the long party.

Strike Price	Spot price	Payoff	Profit
30	10	0	6
30	70	-40	-34

For short, the payoff= Strike - Spot and Profit = Payoff + Premium.

Derivatives are a zero sum game, what is the long's profit is short's loss and therefore the figures are just the negative of each other.