Question

# can someone explain? The stock price of Lotus is currently \$220 and the call option with...

can someone explain?

The stock price of Lotus is currently \$220 and the call option with strike price of \$220 is \$10. A trader purchases 100 shares of Lotus stock and short 1 contract of call options with strike price of \$220. As a financial analyst at Citibank, you want to answers the following two questions:
a.         What is the maximum potential loss for the trader?
b.         When the stock price is \$240 and the call is exercised, what is the trader’s net profit?

 1 When the stock price is \$240 and the call is exercised, the trader’s net profit is \$1000 2 The maximum potential loss for the trader is \$23000 3 The maximum potential loss for the trader is \$20,000 4 When the stock price is \$240 and the call is exercised, the trader’s net profit is \$1300 5 The maximum potential loss for the trader is \$22000 6 When the stock price is \$240 and the call is exercised, the trader’s net profit is \$1200 7 The maximum potential loss for the trader is \$21000 8 When the stock price is \$240 and the call is exercised, the trader’s net profit is \$1100

The maximum loss is computed as follows:

If the stock price will move to 0, then the loss will be as follows:

= (Number of shares x 0 - Number of shares x Purchase price per share) + profit of \$ 10 on call x 100 (The seller of a call option will gain if the price moves down, however the maximum profit will be restricted to the amount of premium)

= (100 x 0 - 100 x \$ 220) + \$ 1,000

= - \$ 22,000 + \$ 1,000

= - \$ 21,000

So, the correct answer is option 7

b. Net profit is computed as follows:

= (Number of shares x stock price of \$ 240 - Number of shares x \$ 220) + (Strike price - stock price + Premium) x 100

= (100 x \$ 240 - 100 x \$ 220) + (\$ 220 - \$ 240 + \$ 10) x 100

= \$ 2,000 - \$ 1,000

= \$ 1,000

So, the correct answer is option 1.

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