Question

An investor owns 5,000 shares of IBM stock, $105 per share. He thinks that there is no large rise and possible drop in price. This investor decides to sell 50 December 110 call option at $4, receiving $20,000. Note: Each call option contract provides for the right to buy 100 shares of stock. December 110 call option means that the strike price of the call is 110 and it matures in December.

If IBM stock price rises from $105 to $115, the profit associated with the passive strategy is_____ and the profit associated with the covered call writing strategy is____.

	A.	$50,000, $40,000
	B.	$50,000, $20,000
	C.	$50,000, $75,000
	D.	$50,000, $45,000

Answer 1

S0	105
K	110
S1	115
profit associated with the passive strategy = (S1-S0)*number of shares = (115-105)*5000	50000
profit associated with the protective put strategy = profit associated with the passive strategy + Option settlement + Premium
profit associated with the protective put strategy = profit associated with the passive strategy + (K-S1)*Number of put options*Lot size + Premium = 50000 + (110-115)*50*100 + 20000	45000
Answer : Option D