Question

Suppose you think Tesla stock is going to appreciate substantially in value in the next year. Say the stock’s current price, S, is $400, and a call option expiring in one year has an exercise price, X, of $390 and is selling at a price, C, of $40. With $40,000 to invest, you are considering three investment alternatives.
Alternative A: Invest all $40,000 in the stock, buying 100 shares.
Alternative B: Invest all $40,000 in 1,000 options (10 contracts).
Alternative C: Buy 100 options (one contract) for $4,000, and invest the remaining fund in a money market fund paying 8% annual interest

Suppose Tesla stock goes up in price to $600 one year later.
a.    What is total value of the investment for alternative A?(sample answer: $185.75)
b.    What is your rate of return for alternative A?(sample answer: 25.30%)
c.    What is total value of the investment for alternative C?(sample answer: $185.75)
d.    What is your rate of return for alternative C?(sample answer: 25.30%)

Answer 1

A) Alternative A is investing entire $40000 in Shares of Tesla which is trading at the price of $400/share.

No. Of Shares bought = $40000/$400 = 100 Shares

Current Market Price of Tesla shares = $600

Value of Investment = $600 * 100 = $60000

B) Rate of Return for Alternative A = (60000 - 40000)/40000 = 50% p.a

C) Value of Investment

i) $36000 * 1.08 = 38880

ii) $(600 - 390) * 100 = 21000

Total = 38880 + 21000 = 59880

D) Rate of Return for Alternative C = (59880 - 40000)/ 40000 = 49.7%