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Homework Question 1) Currently a call contract with an exercise price of $10 on a share...

Homework Question 1) Currently a call contract with an exercise price of $10 on a share of List Aerospace’s common stock is selling for (that is, its premium is) $2. What would the profit or loss graph (similar to that in Figure 20.5 See PowerPoint) look like for this option? In drawing this graph, assume that the option is being evaluated on its expiration date. What are the maximum profits, maximum losses, and the break-even point? How would this graph change if the exercise price was $12 and the price (or premium) of the option was $4?

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Answer #1

Profit/loss for a call option is given by

- call premium if market price < strike price

market price - strike price - call premium if market price > strike price

a). Exercise price = 10; call premium = 2

Maximum loss = call premium = 2;

Maximum profit can be unlimited depending on high the share price rises.

Break-even point will be strike price + call premium = 10 + 2 = 12

b). Exercise price = 12; call premium = 4

Maximum loss = call premium = 4;

Maximum profit can be unlimited depending on high the share price rises.

Break-even point will be strike price + call premium = 12 + 4 = 16

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