Question

Use the following quotes for JCPenney stock options:

November 27, 2015 In The Money List Straddle Lookup Option Calls Strike Fiter Contract Name Last Bid Ask Change %Change Volume Open Interest Implied Volatilty 8.00 1.79 1.89 0.00 0.00% 56.45% 9.00 1.62 0.98 0.74 1.00 0.00 0.00% 51.95% 9.50 0.69 0.00% 50.00% JCP151127C00008000 JCP151127C00009000 JCP151127C00009500 JCP151127C00010000 JCP151127C00010500 JCP151127C00011000 10.00 0.40 0.44 1.10 0.78 0.48 0.29 0.18 0.00% 45.12% 0.00 0.00 0.03 -0.01 10.50 12.00% 43.75% 0.28 0.16 0.26 0.15 11.00 -5.88% 44.34% Puts Strike Fiter Contract Name Last Bid Ask Change %Change Volume Open Interest Implied Volatility 7.00 0.03 0.08 0.00 0.00% 67.58% JCP151127P00007000 JCP151127P00008500 0.06 0.31 8.50 0.00 0.00% 53.13% 9.00 JCP151127P000090000.41 0.18 0.29 0.47 0.21 0.33 0.50 0.00% 50.20% 0.00 0.00 9.50 JCP151127P00009500 0.65 0.00% 49.22%

Assume you purchased the right to sell 3,700 shares of JCPenney stock in November 2015 at a strike price of $7.00 per share. Suppose the stock sells for $6.50 per share immediately before your options’ expiration. What is the rate of return on your investment? What is your rate of return if the stock sells for $8.00 per share? Assume your holding period for this investment is exactly three months. (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Enter your 3-month returns as a percent rounded to 2 decimal places.)

Return on investment at $6.50?

Return on investment at $8.00?

Answer 1

An option that gives the right to sell is a put option.

The last price of the $7.00 strike put options is $0.06. This is the premium paid to buy the options.

$6.50

If the stock sells at $6.50, the put options can be exercised to sell the stock at $7.00. Therefore, the profit is $7.00 - $6.50 = $0.50.

The premium paid to buy the options is $0.06. This is the investment made to earn the profit of $0.50.

Return on investment = (profit - initial investment) / initial investment

Return on investment = ($0.50 - $0.06) / $0.06

Return on investment = 733.33%

$8.00

If the stock sells at $8.00, the put options will expire worthless.

The premium paid to buy the options is $0.06. The entire premium is lost, and no profit is earned.

Return on investment = (profit - initial investment) / initial investment

Return on investment = ($0 - $0.06) / $0.06

Return on investment = -100.00%