Questions and answers

Chapter 1 questions

Here are a few questions on call contracts. Don’t expect to know all the

answers. The answers are given, so you should treat the questions as addi-

tional examples from which to learn.

1 GE is currently trading at 18.03, and the April 19 calls are trading at 0.18.

(a) If you buy one of these calls at the current market price, what is

your break-even level?

(b) What is the maximum amount that you can gain?

(c) What is the maximum amount that you can lose?

(d) Answer questions a–c for a sale of this call.

(e) The multiplier for this options contract is $100, or 100 shares.

What is the cash value of this call?

(f) Write a profit/loss table for a buy of this call at expiration.

(g) Graph the profit/loss for a buy of this call at expiration.

(h) Answer questions f–g for a sale of this call

(i) If at April expiration, GE closes at 19.00 what is the profit/loss for

the call buyer and for the call seller?

(j) If at April expiration, GE closes at 19.10 what is the profit/loss for

the call buyer and for the call seller?

246 Questions and answers

2 This is a question to get you thinking about risk and return.

Unilever is currently trading at 553p (£5.53)

1

, and the March 550 calls are

trading at 74p (£0.74). This year, Unilever shares have ranged from 346.75

to 741. You foresee a continued volatile market and you think that food

producers will attract buying interest as defensive investments. Because of

market volatility you hesitate to risk an outright purchase of shares, and you

would like to compare the risk of a call purchase.

(a) If you buy one of these calls at the current market price, what is

your break-even level?

(b) What is the maximum amount that you can gain?

(c) What is the maximum amount that you can lose?

(d) Answer questions a–c for a sale of this call.

(e) The multiplier for this options contract is £1,000, or 1,000 shares.

What is the cash value of one of these calls?

(f) If at March expiry Unilever closes at 650, what is the profit/loss for

the call buyer, and for the call seller?

(g) What is the amount of capital at risk for the call buyer versus the

buyer of 1,000 shares? Calculate the difference.

(h) If by March Unilever has retraced to its former low, what would

be the amount lost on buying the shares versus buying the call?

Calculate the difference.

Calculate the risk/risk ratio.

(i) If by March of next year Unilever has rallied to its former high,

what would be the amount gained on buying the shares versus

buying the call?

Calculate the difference.

Calculate the return/return ratio.

(j) Looking at the above risk scenario h), and the above return sce-

nario i), compare the risk/return ratios of the shares position

versus the call position.

This is just one method of accessing risk/return. The point is that

you do need to have a method.

1

A recent price of Unilever is 1961p. If you wish, you can substitute another share at this

price level. Examples like this are why this book is used in university courses.

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