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Coursework question 12.3 The price of a security is £10 today. Suppose that you are the only person in the world who knows that the price of the security will be £25 in 3 months, while everybody else expects that the price will stay around £10 a) Suppose you would like to buy a call option today with strike price £15 and maturity 3 months. Explain why this call option will be cheap. b) Explain briefly how you can make money with call options in this situation. c Suppose you have £75,000 available. Would you invest the money in this situation 1) into call options or buy the security directly? Justify your answer

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Answer #1

a) Since the share price is going to increase the call option value will rise atleast upto 10. (25- 15).

b) By buying the call option we can earn money.

c) One should invest in the call option as it is gives more return as compare to stock.

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