Intro

An investor believes that the Cisco stock price is going to

increase in the following $12$ months from the current stock

price of $$200.$ Call options on Cisco stock expiring in $12$

months have a strike price of $$211$ and sell at a premium of

$$20$ each. The investor has $$8,000$ to invest, and is considering

$3$ alternatives:

Purchase $400$ call options.

Purchase $40$ shares.

Invest $$7,200$ in a money market fund returning $6\%$ per year

and buy $40$ call options with the remaining money.

Assume that the stock price will be $$236$ per share after $12$

months.

Part $1$

What will be the investor's rate of return for alternative $1?$

Correct $$

Because the Cisco stock price is above the strike price the

investor will exercise the options.

Option payoff on the expiration date

$=S_T-x$

$=236-211$

$=25$

Net profit

$=$ Number of options ${?}^{**}($Payoff $-$ Premium$)$

$=400*(25-20)$

$=2,000$

Rate of return:

$r=$ Profit $/$ Investment

$=2,\frac{000}{8},000$

$=0\mathrm{.}25$

Part $2$

What will be the investor's rate of return for alternative $2?$

Correct $$

Rate of return:

$r=$ Value of shares $/$ Investment $-1$

$=\frac{40**236}{8},000-1$

$=0\mathrm{.}18$

Part $3$

What will be the investor's rate of return for alternative $3?$