Question

Suppose you think FedEx stock is going to appreciate substantially in value in the next 6 months. Say the stock's current price is $100, and a call option expiring in 6 months has an exercise price of $100 and is selling at a premium of $10. With $10,000 to invest, you are considering investing all $10,000 in 100 options (one contract) for $1,000 and invest the remaining $9,000 in a money market fund paying 4% in interest over 6 months (8% per year). Compute the total value of your portfolio 6 months from now if the price of FedEx stock is:

A) $100.

B) $120

Answer 1

Solution :-

Current Investment = $10,000

Investment in Options (Options Premium) = $10 * 100 = $1,000

Remaining Investment in Money Market Fund = $9,000 @ 8% per year

Now in

Case (i)

Value of Share after 6 months = $100

Exercise price = $100

Net Profit = $0 - $1,000 = - $1,000 (As loss of Option Premium )

Now Value of Money Market Fund investment = $9,000 * ( 1 + 0.04 ) = $9,360

Value of Portfolio = $9,360

Case (ii)

In Case Market Price of Share $120

Profit on Option = ( $120 - $100 ) = $20 Per share

Net Profit Per Share = $20 - $10 = $10

Value of Options after 6 months = $10 * 100 = $1,000

Now Value of Money Market Fund investment = $9,000 * ( 1 + 0.04 ) = $9,360

Therefore Value of Portfolio = $9,360 + $1,000 = $10,360

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