Question

Assume that at t = 0 a stock has price S = $500 and that a...

Assume that at t = 0 a stock has price S = $500 and that a call that matures at T with a strike price of X = $500 has premium C = $10.

Assume at the option’s maturity, t = T, that ST = $550.

Assume that at t = 0 that investor #1 buys 100 shares of stock and sells them at t = T.

Assume that at t = 0 investor #2 buys one call option on the same stock & exercises it at t = T.

What is the ROI (return on investment) for investor #2?

None of these numbers are correct

300%

200%

100%

400%
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Answer #1

Answer: 400%

At t = 0,
Stock Price (S) = $ 500
Strike Price of Call maturing at time T = $ 500
Premium of Call Option, C = $ 10
At t = T,
Stock Price (ST) = $ 550
As Stock Price at Expiry is higherthan Strike Price, Call Option can be excercised
Payoff of Call Option at the time of Expiry = ST - Strike Price
Payoff of Call Option at the time of Expiry = $ 550 - $ 500 = $ 50 per Option
Return of Investor #2 = Payoff of Call Option - Option Premium paid
= $ 50 - $ 10 = $ 40
Retun on Investment = ($ 40/ $10) x 100
Retun on Investment = 400%
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