Question

A call option on 100 shares of stock is purchased for a premium of $400. The current price of the stock is $42 per share, and the exercise price is $44 per share. The option is exercised when the stock is selling for $50 per share. What would be your return on the option if after exercising it, you immediately sold the stock at the market price of $50 per share? Ignore taxes and brokerage commissions.

A) 8%
B) 12%
C) 50%
D) 200%

Answer 1

The return on the option would be 150%.

Step-by-step explanation:

To calculate the return on an option, you first need to determine the total cost of the option. In this case, the premium paid for the call option on 100 shares of stock is $400. Since there are 100 shares, the total cost of the option is $400.

Next, you calculate the profit from exercising the option and selling the stock. To exercise the option, you would need to buy 100 shares of stock at the exercise price of $44 per share, which would cost $4,400. You would then sell these 100 shares at the market price of $50 per share, which would generate $5,000 in revenue.

Finally, you subtract the total cost of the option from the revenue generated from selling the stock to calculate the return. In this case, the return would be $5,000 - $4,400 = $600. To determine the return as a percentage, you divide the return by the total cost of the option and multiply by 100. So, the return on the option would be ($600 / $400) * 100 = 150%.