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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