Question

Information on problem: You purchase 500 shares of BOB stock at 37.15 and sell 5 BOB Dec 40 call options at 2.50 each.

1a Above what price on the stock would you end up with a greater total gain had you simply owned the stock and not sold the calls?

1b If the stock is 41 at expiration, and you do not repurchase the option, what will happen?

1c Excluding commissions, what price on the stock represents your breakeven point at expiration?

Answer 1

1a.

Amount received from options = 500*2.5 = $750

This $750 is received on 5 lots of shares, which is 500 shares

So share of each share = 750/500 = $1.5

Price of the stock at which you would end up with greater total gain had you simply owned the stock and not sold the calls = 37.15 + 1.5 = $38.65

1b.

If the stock is 41 at expiration, call option holder will exercise the option, and buy the shares @ $40.

Total payoff = Option premium - Shares * purchase price + shares*strike price

= 500*2.5 - 500*37.15 + 500*40 = $2675

1c.

At breakeven price payoff is zero

Premium - Shares purchase price - Breakeven price + Strike price = 0

Breakeven price = 2.5-37.15+40 = $45.35