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Options/Future Markets

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Allen has been investing in the stock market for quite some time and had some success with equity investments. Recently, a friend suggested that he start to use options in his portfolio as a means to increase his returns. Allen decided to purchase a March, 2009 expiration call option on Stock X, which carried an exercise price of $500 that was selling for $15. Two weeks later, shares of Stock X were trading for $480.6. Now that the stock price is lower than the purchase price, the options are worthless. However, when Allen waited an additional two weeks, the stock price climbed to $510. Allen, feeling a bit of anxiety, decides to exercise the option and realize some gains.

-In exercising this option, what price is Allen getting the stock for?
-What is the value at exercise of the option?
-Calculate the profit or loss on this transaction.
-How might Allen have covered this position to limit his exposure?
-How might you use calls like this to increase an investments performance?

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Solution Preview

If Allen exercises his options, he will get the stock at the exercise price of $500. However, his total purchase cost at exercise of option will be $515 ($500 exercise price plus $15 cost of call option).

If he exercises the option, gets the stock and sells it at market price of $510, he will loose $5 per stock as his total ...

Solution Summary

Discusses a scenario related to stock options.

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6. You note that platinum sells for $750 per ounce and know that it will sell for either $850 or $750 in one year. There are call options and put options for platinum. There are also futures markets for platinum. The safe rate of interest is10%. You can ignore all storage and transportation costs.
a. You observe a derivative contract (some unknown combination of calls, puts, written calls, written puts) that pays off $90 if platinum is selling for $850 in a year and pays off $110 if is selling for $750. In a competitive market with no arbitrage opportunities, what should the cost be for this derivative?
b. Also in a competitive market with no arbitrage opportunities, what should the futures contract for delivery of one ounce of platinum in one year be selling for today?

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