Carol Krebs is considering buying 100 shares of Sooner Products, Inc at $62 per
ID: 2660842 • Letter: C
Question
Carol Krebs is considering buying 100 shares of Sooner Products, Inc at $62 per share. Because she has read that the firm will probably soon receive certain large orders from abroad, she expects the price of Sooner to increase to $70 per share. As an alternative, Carol is considering purchase of a call option for 100 shares of Sooner at a strike price of $60. The 90-day option will ost $600. Ignore any brokerage fees or dividends.
a. What will Carol's profit be on the stock transaction if its price does rise to $70 and she sells?
b. How much will Carol earn on the option transaction if the underlying stock price rises to $70?
c. How high must the stock price rise for Carol to break even on the option transaction?
d. Compare, contrast, and discuss the relative profit and risk associated with the stock and the option transactions?
**Show work please***
Explanation / Answer
a)
Carol's profit be on the stock transaction if its price does rise to $70 and she sells=100*(70-62)=$800
b)
Carol earn on the option transaction if the underlying stock price rises to $70=100*(70-60) - cost(=$600)=$400
c)
To breakeven,
cost invested=return
Let stock price be x
60*100+$600=100*x
x=$66
d) The profit is higher in case of Stocks but have more risk associated with it. Options are safer but extra cost has to be paid for it.