Question

You buy one contract for a 6-month European call option in June 2010 for $1.25 with exercise price of $18.00. On September 1, 2010, the stock reaches its 52-week low at $12.65 per share. On December 16, 2010, the stock is selling at $16.75. What is your profit or loss on the purchase?

Answer 1

An investor who purchases a call is bullish on the stock believes that the underlying stock price will rise and that they will be able to profit from the price appreciation by purchasing calls.

For a long in call option, the payoff is written as:

Long Call Payoff = [Max (0, Stock Price - Strike Price)] - Premium

This means, a long position in a call has an unlimited profit potential, whereas the loss for the position is capped at the premium paid.

Now, in the question, since stock price is below the stock price, it is a loss for the investor.

However, the loss is capped at premium.

Hence the loss in this question = $1.25