Question

Company A’s stock is currently selling at $200 per share. A one-year American call option with strike price $50 trading on the Acme options exchange sells for $75.

(1) How would you take this opportunity to make a profit?

(2) Suppose the option is a European call option instead, what is your strategy to make a profit?

Answer 1

1. Let suppose we buy a call option at $75 (per 10 shares lot) at a strike price of $50 it means that whatever the price at future date, we have an option to buy the shares at $50. So lets say that on we buy the shares at $50 x 10 shares = $500 and the market price is $210 then we made a profit of $210 - $50 = $160 x 10 shares = $1600 - $75 (premium) = $1525 profit.

2. The different between the American option and European option is that at European option, it is exercised only at maturity whereas on the american it can be exercised only at the expiry. So in this scenario, we would make a profit if on the expiry shares are trading above the strike price.