QUESTION 26

1. Barry believes that due to COVID-19 the price of a listed pharmaceutical company BigPharma Ltd is expected to rise in the next few months. Barry does not currently have the cash flow required to buy the share but finds a call option with an expiry of 2 months, an exercise price of $80 and a premium of $4.50. The current share price of BigPharma Ltd is $70.00.

   (a) In order for Barry to benefit from the expected rise in the BigPharma Ltd share price, should he buy or sell the call option? What will be the initial cash flow from this position? (2 marks)

   (b) Explain when Barry would exercise the option. (2 marks)

   (c) Calculate the breakeven point of the option, and the profit/loss to Barry if at expiry of the option, BigPharma's share price was $90. (4 marks)

   (d) Is there a way Barry could have profited from an expected price increase using put options? If so, explain how. Describe any additional risks that would have been involved. (2 marks)