Question

Consider a stock priced at $30 with a standard deviation of 0.3. The risk-free rate is 0.05. There are put and call options available at exercise prices of 30 and a time to expiration of six months. The calls are priced at $2.89 and the puts cost $2.15. There are no dividends on the stock and the options are European. Assume that all transactions consist of 100 shares or one contract (100 options). Ignore the time value of money!

What is the maximum profit that the writer of a call can make?

Select one:

a. $328

b. $211

c. $289

d. $237

Answer 1

Maximum profit writer can make is $2.89 x 100 = $289.

In case you write a call, and price goes up on expiry, then the option buyer will exercise his option and you will have to buy shares from him@ strike price and sell on the market. This will incur a loss to you. Your profit in this case would be - $289 less loss on options. In case price goes down, then the option buyer will not exercise his options as he would not want to have a loss. So, profit in this case would be $289. In either case, profit will not be more than $289, which is the maximum profit.