Question

7. On April 3, 2017 the closing price of ABC stock was $102. After trading closed the company announced news that was perceived by the market to be good. On April 4, the stock opened at $126. During the day, the market decides that the news was bad and the stock actually goes down to $95. When the stock was trading at $97 an investor who owned the stock sold a call on the stock that will expire in 13 months. If getting the preferred tax rate on dividends is important to the investor.

a. what is the lowest strike price call that the investor can sell? Assume that the strike prices are in $5 increments.
b. doesn't the move in the price affect the answer
c. what about the term of the otion?

Answer 1

A) When the stock was trading at $97, the investor who owned the stock should sell the call with strike price $100 as this will help in hedging the long position in the stock and the investor will get the benefit of call premium if the stock price further falls. If the stock price increases, then the investor will get the benefit from having the long position in the stock.

B) Yes, the movement in the price affect the answer. If the price further falls, then it would be better for selling further lower strike price call which would earn the investor further higher premium.

C) Since, the term of the option is 13 month which is very fall away, this will lead to higher premium on the call as compared to another call option which is having an earlier expiry.