Question

Path:P Words 0 Sve QUESTION 4 Suppose you simultaneously short ExxonMobil Stock at a price of S90 per share and purchase a one-year call option with strike price of $100 for $1.254. What is the largest profit you can eam on this position? TT T Arial 3 (12pt) Words:0 Path 0 points (E

Answer 1

Call Option Buyer has a Right but NOT an Obligation to Buy the underlying stock at Strike Price. Therefore, he will Exercise his Option to Buy Only if he is in profit i.e. Spot Price at expiry is Greater than Strike Price. Therefore, Maximum Possible Loss on Call Bought is the Premium Paid. And, Maximum Possible Profit is Unlimited(because Stock can Go Up till Infinity)

Short Position will make Profit if Stock will go down. Stock can go down to a Maximum of 0. Therefore, Maximum Profit on Short Position is limited to the price at which Short position is entered. But, Maximum Loss is Unlimited.

In given case, if Stock start miving up, we will immediately start losing in the Short position in stock. Call will make profits after price starts going beyond $100, but that profit will be offset by the Short position. Therefore, in short, if price goes up, we don't make any profit. There will be a loss.

Now, if price start down, we will immediately start making profit in the short position. And, our loss in Call Option is limited to premium paid. Therefore, Maximum Profit will happen if Stock Price goes to 0.

Maximum Profit = Profit on Short Position-Loss on Call Option = (Selling Price-0)-Premium Paid = (90-0)-1.254 = $88.746