Assignment 1 Chapter 6

Call Option Lecture Problem

Hatem Hassan Zakaria

Problem

Given the following information, kindly calculate the Profit and Loss Positions for
Both Holder and Writer of a Call option at Prices 85, 90, 95,100,110,115,120 and
Support your answers in Graph

Option Contract
Stock ABC
Exercise Price(X) = 100 $
Premium = 10$
Contract Size (NC) = 1000
Time to Expiration (T) = 2 Months

Answer
A. Holder of a Call Option

The long call option strategy is the most basic option trading strategy whereby the
options trader buy call options with the belief that the price of the underlying security
will rise significantly beyond the strike price before the option expiration date.
Leverage
Compared to buying the underlying shares outright, the call option buyer is able to gain
leverage since the lower priced calls appreciate in value faster percentagewise for every
point rise in the price of the underlying stock
However, call options have a limited lifespan. If the underlying stock price does not
move above the strike price before the option expiration date, the call option will expire
worthless.

Unlimited Profit Potential

Since they can be no limit as to how high the stock price can be at expiration date, there
is no limit to the maximum profit possible when implementing the long call option
strategy.
The formula for calculating profit is given below:

Maximum Profit = Unlimited

Profit Achieved When Price of Underlying >= Strike Price of Long Call +
Premium Paid
Profit = Price of Underlying - Strike Price of Long Call - Premium Paid

Limited Risk
Risk for the long call options strategy is limited to the price paid for the call option no
matter how low the stock price is trading on expiration date.
The formula for calculating maximum loss is given below:

Max Loss = Premium Paid + Commissions Paid

Max Loss Occurs When Price of Underlying <= Strike Price of Long Call

Breakeven Point(s)
The underlie price at which break-even is achieved for the long call position can be
calculated using the following formula.

Breakeven Point = Strike Price of Long Call + Premium Paid

Current Stock Price (

85
90
95
100
110
115
120
Decision for Investor:

Decision
No Exercise (Limited
Loss=Premium)
No Exercise (Limited
Loss=Premium)
No Exercise (Limited
Loss=Premium)
No Exercise (Limited
Loss=Premium)
Exercise(Break Even Point)
Exercise
Exercise

Profit & Loss

10$*1000=-10,000
10$*1000=-10,000
10$*1000=-10,000
10$*1000=-10,000
-100+110-3=0
-100+115-10=5$*1000=5000
-100+120-10=17$*1000=10000

1. Limited Loss is the Premium Paid

2. Unlimited Profit as long as Prices goes up(bullish Outlook)
3. Break Even Point = Strike Price + Premium Paid = 100+10=110$

20

Profit & Losse ($)

15
10
5
0
-5
-10
-15
85

90

95

100

110

15

120

Strike Prices

B. Writer of A Call Option

Current Stock Price Decision
( )
Holder will not exercise and Thus
85
Premium is Limited reward for the
Writer
Holder will not exercise and Thus
90
Premium is Limited reward for the
Writer
Holder will not exercise and Thus
95
Premium is Limited reward for the
Writer
Holder will not exercise and Thus
100
Premium is Limited reward for the
Writer
Break Even Point
110
Holder will Exercise and Thus result
115
in a Loss for Writer of a Call Option
Holder will Exercise and Thus result
120
in a Loss for Writer of a Call Option

Profit & Loss

10$*1000=+10,000

10$*1000=+10,000

10$*1000=+10,000

10$*1000=+10,000

+100-110+10=0
+100-115+10=-5*1000=-5000
+100-120+10=-10*1000=-10000

15

Profit & Losse ($)

10
5
0
-5
-10
-15
85

90

95

100

110

115

120

Strike Prices

Decision for Investor:

1. Limited Profit = Premium
2. Unlimited Loss as long as Current Stock Price is higher Than stock price

The expression "writing an option" refers to the act of selling an option. An option is the
right, but not the obligation, to buy or sell a particular trading instrument at a specified
price, on or before its expiration.
When someone writes (or "sells") an option, he or she must deliver to the buyer a
specified number of shares if the option is excercised The writer has an obligation to
perform a duty while the buyer has the option to take action. There are two general types
of option writing: covered and naked.
In a covered call, the option writer already owns the underlying trading instrument and
wishes to make extra money from the position. He or she can write (or sell) an option
based on the expectation that the underlying's price will move in a particular way. The
buyer pays the writer a premium in exchange for writing the option.
If the option trades at a value that benefits the buyer, the seller is obligated to hand over
the shares. If the option expires at a value that does not benefit the buyer, the seller
retains the original shares. If the option writer does not own the underlying instrument, it
is said to be a "naked" option. This is more risky than writing a covered call since the
writer is still obligated to produce the specified number of shares of the particular
contract (without already owning them).