Question

Charleston Investment Company just purchased Renfro stock for $50. It engages in a covered call strategy whereby it sells call options on Renfro stock. A call option on Renfro stock is available with an exercise price of $52, a one-year expiration date, and a premium of $2. Assume that the buyers of the call option will exercise the option on the expiration date if it is feasible to do so. Charleston will sell the stock at the end of one year even if the option is not exercised. Determine the net profit per share for Charleston based on the following possible prices for Renfro stock at the end of one year:

d. $53

e. $55

Answer 1

Ans d) If stock price is $53 then the profit on stock position will be equal to $3 ($53 - $50). And the profit from selling call will be $2. But call holder will exercise the option and there will be payoff of $1 ($53 - $52).

Thus total profit will be = Profit from stock appreciation + call premium - call payoff

= $3 + $2 - $1

= $4

Ans e) Similarly we will find for $55

Thus total profit will be = Profit from stock appreciation + call premium - call payoff

= ($55 - $50) + $2 - ($55 - $52)

= $4