Question

Problem 14-04

You strongly believe that the price of Breener Inc. stock will rise substantially from its current level of $138, and you are considering buying shares in the company. You currently have $12,420 to invest. As an alternative to purchasing the stock itself, you are also considering buying call options on Breener stock that expire in four months and have an exercise price of $140. These call options cost $10 each.

1. Compare and contrast the size of the potential payoff and the risk involved in each of these alternatives. Do not round intermediate calculations. Round your answers to the nearest whole number.

   With $12,420 to spend, one could:
   Purchase     shares of Breener Inc. stock
   Purchase     call options

   Potential payoff is unlimited in -Select-case of purchasing sharescase of purchasing the stockboth casesItem 3 . Both the options will provide a -Select-higher lowerItem 4 percentage gain (loss) than purely purchasing stock.

2. Calculate the four-month rate of return on both strategies assuming that at the option expiration date Breener's stock price has (1) increased to $157 or (2) decreased to $136. Do not round intermediate calculations. Round your answers to two decimal places. Use a minus sign to enter negative values, if any. If the answer is zero, enter "0".

   1. Stock return:   %

      Option return:   %

   2. Stock return:   %

      Option return:   %

3. At what stock price level will the person who sells you the Breener call option break even? Assume that the call was uncovered. Round your answer to the nearest dollar.

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Problem 14-04 You strongly believe that the price of Breener Inc. stock will rise substantially from its current level of $138, and you are considering buying shares in the company. You currently have $12,420 to invest. As an alternative to purchasing the stock itself, you are also considering buying call options on Breener stock that expire in four months and have an exercise price of $140. These call options cost $10 each. a. Compare and contrast the size of the potential payoff and the risk involved in each of these alternatives. Do not round intermediate calculations. Round your answers to the nearest whole number. With $12,420 to spend, one could: Purchase shares of Breener Inc. stock Purchase call options Potential payoff is unlimited in -Select- . Both the options will provide a -Select- percentage gain (loss) than purely purchasing stock. b. Calculate the four-month rate of return on both strategies assuming that at the option expiration date Breener's stock price has (1) increased to $157 or (2) decreased to $136. Do not round intermediate calculations. Round your answers to two decimal places. Use a minus sign to enter negative values, if any. If the answer is zero, enter "O". 1. Stock return: Option return: 2. Stock return: Option return: c. At what stock price level will the person who sells you the Breener call option break even? Assume that the call was uncovered. Round your answer to the nearest dollar.

Answer 1

a)

With 12420 to spend one could

Purchase =12420/138 = 90 Shares of Breener Inc.

Purchase =12420/10 = 1242 Call Options

Potential Payoff is unlimited in Call Options (As Call can go up unlimited as stock price has no upper cap) . Both the options will provide a high percentage gain (loss) tha purely purchasing stocks (As quantity is high in case of option in comparison to stock)

b)

increases to 157

Return = Current Price / Invested Price - 1

Stock Return = 157 / 138 = 1.13768 - 1 = 0.13768 = 13.77%

Option Return = 157 - 140 = 17 /10 = 1.7 - 1 = 70%

Decreases to 136

Stock Return = 136 / 138 = 0-98551 - 1 = -0.98551 = - 1.45%

Option Return = in case of call if price is below strike price I will loose entire money invested = so loss is - 100%

c)

at 150 person who sold me call is at breakeven .

he sold so he got $10 now if price go to 150 I will exercise my right and he has to give me stock so till 150 he is not loosing anything.