Final answer:
Tammy Smith's return on investment (ROI) from exercising her call option when the stock price rose to $45.00 is approximately 42.86%. She realized a profit of $1.50 per share, which translates to a total profit of $150 for a 100 shares contract, on her initial investment of $350.
Step-by-step explanation:
When Tammy Smith purchased a call option with a striking price of $40 at a price of $3.50, she was engaging in a financial transaction that involves a form of derivative known as options trading. An option gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified strike price before the option expires. In the scenario described, Tammy is exercising a call option because the stock price at expiration is $45.00, which is higher than the strike price of $40.00.
To calculate Tammy's return on investment (ROI), we look at the profit she made from the transaction and then divide this by the total investment she made. The profit is determined by subtracting the sum of the strike price and the price of the option from the stock price at expiration. So, Tammy's profit is $45.00 (stock price at expiration) - $40.00 (strike price) - $3.50 (price of the option) = $1.50 per share. As options contracts typically represent 100 shares, Tammy's total profit would be $1.50 x 100 = $150.00.
Her initial investment was the cost of purchasing the option, which is $3.50 x 100 shares = $350.00. The ROI, therefore, is $150.00 profit รท $350.00 initial investment, resulting in approximately a 42.86% return on Tammy's investment.