Question

1) A call option on FDX stock specifies a strike price of $180. Today’s price of the stock is $174. The premium on the call option is $5. What price does FDX stock have to reach in order to break even assuming no transaction costs?

2) Compared to the FDX call option above with another FDX call option with an exercise price of $190 and a premium of $1. What might an investor who prefers the $190 strike, $1 call option expect compared to an investor who prefers the $180 strike price, $5 option? Which one would be able to leverage capital more to take advantage of the stock moving to $200 based on some extremely good news about FDX?

Answer 1

1) Strike Price = $180

Premium = $5

Therefore breakeven will be when stock reaches $185

When stock reached $185, payoff from call option will be $185-$180 = $5

Then Call Option will break even

2) If stock reaches $200

Value of call option with $190 strike = $200-$190 = $10

Therefore, Profit on call option with $190 strike = $10-$1 = $9

% returns = $9/$1 = 900%

Value of call option with $180 strike = $200-$180 = $20

Therefore, Profit on call option with $180 strike = $20-$5 = $15

% returns = $15/$5 = 300%

Therefore investor will prefer option with strike price of $190 since leverage benefit is high in option with strike of $190