Question

Suppose you believe that the price of Stock X is going to increase from its current level of $18 during

the next several months. For $4 you buy a call option giving you the right to buy 1 share at a price

of $24 per share.

d. Calculate the net profit percentage (rate of return) on the option.

e. Calculate the breakeven price of the stock--the stock price that would produce neither a

net profit nor a net loss for the buyer of the call option. (Ignore any option time value.)

f. Suppose you are the writer of this call option. If the price of the stock is $24 at the expiration

date, calculate the dollar amount of income you earned by writing the option.

Answer 1

d) The net profit percentage rate can only be calculated if you have exercised the option. If you have not exercised the option and it expires without being used then your rate of return would be zero. In this case the strike price is $24, and the premium paid is $4, so if stock price is less than $24, the option would not be exercised and return would be zero.

e) The breakeven price for a long call option would be the strike price plus the premium paid for purchase of the option.

= 24 + 4 = 28

f) If at the end of the expiry of the option the stock price is $24, then as a writer of the option, you have gained $4 premium per share, as the market stock price is equal to strike price.