Suppose you believe that Johnson Company's stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $310.25 you can buy a 5-month call option, giving you the right to buy 100 shares at a price of $25 per share. If you buy this option for $310.25 and Johnson's stock price actually rises to $45, what would your pre-tax net profit be?
a. -$310.25
b. $1,689.75
c. $1,774.24
d. $1,862.95
e. $1,956.10
Question
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FACTS(1) The call option covers 100 shares
(2) The option price is $310.25
(3) Stock price rises to $45
(4) Current stock price is $22.50
(5) You would pay$25 for the stock should you exercise the option
SOLUTION
Step 1
To calculate the pre-tax profit, you compute the profit you would make per share, and then deduct the amount you paid for the call option. Since you bought the call option when the price was $22.50, and you would pay $25 per share, and the stock price has now risen to $45, your profit per share is:
Profit per share = $45 - $25 = $20...
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