Question

Hazard Company entered into a call option contract for speculation with a bank speculator on January...

Hazard Company entered into a call option contract for speculation with a bank speculator on January 1, 2019. The contract gave the entity the option to purchase 10,000 shares at P100 per share. The option expires on April 30, 2019 at which time the entity paid P10,000 for the call option. The price per share is P120 on April 30, 2019, and the time value of the option has not changed. In order to settle the option contract, the entity would most likely

a. Pay the bank P200,000

b. Purchase the shares at P100 per share and sell the shares at P120 per share to the bank

c. Receive P200,000 from the bank

d. Receive P190,000 from the bank

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Answer #1

Answer: C. Receive P 200,000 from the bank

Explanation:

  • Entity got the right to purchase 10,000 shares at P100 per share. So, entity purchased call option for 10,000 shares with strike price of P100 per share.
  • Entity has paid premium of P10,000 to the bank for call option.
  • So, now option will be settled between bank and entity as per movement in current stock price.
  • Current price of stock is P120.So, Payoff of call option = Spot price -Strike price = P120 - P100 = P 20 per stock.
  • Total payoff = 10,000* P 20 = P 200,000.
  • For the stock option, cash settlement is prevalent and physical delivery of stock is not required. So, Bank will pay the settlement to the entity of P200,000.
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