Suppose you think FedEx stock is going to appreciate substantially in value in the next 6 months. Say the stock's current price, S0, is $100, and the call option expiring in 6 months has an exercise price, X, of $100 and is selling at a price, C, of $10. With $10,000 to invest, you are considering three alternatives.

(a) Invest all $10,000 in the stock, buying 100 shares.

(b) Invest all $10,000 in 1,000 options (10 contracts).

(c) Buy 100 options(one contract) for $1,000, and invest the remaining $9,000 in a money market fund paying 4% in interest over 6 months (8% per year). What is your rate of return for each alternative for the following four stock prices 6 months from now? Summaries your results in the table and diagram below.

Table

Price of Stock 6 Months from Now

$80 $100 $110 $120

a. All stocks (100 shares)

b. All options (1,000 shares)

c. Bills + 100 options

Diagram

Simple graph with rate of return on the vertical axis and the stock price on the horizontal axis.

Rate of return

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0 |___________________________St (stock price)