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Options Trading Profit Analysis

The document outlines a tutorial on European options, including scenarios for profit and loss for various options such as puts and calls. It includes exercises on calculating profits based on stock prices at maturity, as well as discussions on hedging strategies for foreign exchange risk. Additionally, it provides specific calculations for traders' gains or losses based on option prices and market conditions.

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anselanasrym
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23 views11 pages

Options Trading Profit Analysis

The document outlines a tutorial on European options, including scenarios for profit and loss for various options such as puts and calls. It includes exercises on calculating profits based on stock prices at maturity, as well as discussions on hedging strategies for foreign exchange risk. Additionally, it provides specific calculations for traders' gains or losses based on option prices and market conditions.

Uploaded by

anselanasrym
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

FIN4219/FIN4236

Tutorial 5
1. An investor buys a European put on a share for $3. The stock price is $42 and the strike
price is $40. Under what circumstances does the investor make a profit? Under what
circumstances will the option be exercised? Draw a table and a diagram (graph) showing
the variation of the investor’s profit with the stock price at the maturity of the option. You
may assume the stock price is as low as $22 (in even multiples) and as high as $72.

2. An investor sells a European call on a share for $4. The stock price is $47 and the strike
price is $50. Under what circumstances does the investor make a profit? Under what
circumstances will the option be exercised? Draw a table and a diagram (graph) showing
the variation of the investor’s profit with the stock price at the maturity of the option. You
may assume the stock price is as low as $17 (in even multiples) and as high as $77.

3. Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held
until maturity. Under what circumstances will the holder of the option make a profit? Under
what circumstances will the option be exercised? Draw a table and a diagram (graph)
illustrating how the profit from a long position in the option depends on the stock price at
maturity of the option. You may assume the stock price is as low as $80 (in multiples of
$10) and as high as $120.

4. Suppose that a European put option to sell a share for $60 costs $8 and is held until
maturity. Under what circumstances will the seller of the option (the party with the short
position) make a profit? Under what circumstances will the option be exercised? Draw a
diagram illustrating how the profit from a short position in the option depends on the stock
price at maturity of the option. You may assume the stock price is as low as $40 (in even
multiples) and as high as $70.

5. The treasurer of a corporation is trying to choose between options and forward contracts to
hedge the corporation’s foreign exchange risk. Discuss the advantages and disadvantages
of each.

6. A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option
on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options
and one put option.

(i) What is the breakeven stock price, above which the trader makes a profit?

(ii) What is the breakeven stock price below which the trader makes a profit?

1
7. A trader buys 100 European call options (i.e., one contract) with a strike price of $40 and
a time to maturity of one year. The cost of each option is $4. The price of the underlying
asset proves to be $50 in one year. What is the trader’s gain or loss? Show a dollar amount
and indicate whether it is a gain or a loss.

8. A trader sells 100 European put options (i.e., one contract) with a strike price of $100 and
a time to maturity of six months. The price received for each option is $8. The price of the
underlying asset is $82 in six months. What is the trader’s gain or loss? Show a dollar
amount and indicate whether it is a gain or a loss.

9.
(a) Alice purchased a put option on British pounds for $.04 per unit. The strike price was $1.80
and the spot rate at the time the pound option was exercised was $1.59. Assume there are
31,250 units in a British pound option. What was Alice’s net profit on the option?

(b) Brian sold a put option on Canadian dollars for $.03 per unit. The strike price was $.75,
and the spot rate at the time the option was exercised was $.72. Assume Brian immediately
sold off the Canadian dollars received when the option was exercised. Also assume that
there are 50,000 units in a Canadian dollar option. What was Brian’s net profit on the put
option?

2
1. An investor buys a European put on a share for $3. The stock price is $42 and the strike
price is $40. Under what circumstances does the investor make a profit? Under what
circumstances will the option be exercised? Draw a table and a diagram (graph) showing
the variation of the investor’s profit with the stock price at the maturity of the option. You
may assume the stock price is as low as $22 (in even multiples) and as high as $72.
Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held
until maturity. Under what circumstances will the holder of the option make a profit? Under
what circumstances will the option be exercised? Draw a table and a diagram (graph)
illustrating how the profit from a long position in the option depends on the stock price at
maturity of the option. You may assume the stock price is as low as $80 (in multiples of
$10) and as high as $120.
2. An investor sells a European call on a share for $4. The stock price is $47 and the strike
price is $50. Under what circumstances does the investor make a profit? Under what
circumstances will the option be exercised? Draw a table and a diagram (graph) showing
the variation of the investor’s profit with the stock price at the maturity of the option. You
may assume the stock price is as low as $17 (in even multiples) and as high as $77.
4. Suppose that a European put option to sell a share for $60 costs $8 and is held until
maturity. Under what circumstances will the seller of the option (the party with the short
position) make a profit? Under what circumstances will the option be exercised? Draw a
diagram illustrating how the profit from a short position in the option depends on the stock
price at maturity of the option. You may assume the stock price is as low as $40 (in even
multiples) and as high as $70.
5. The treasurer of a corporation is trying to choose between options and forward contracts to
hedge the corporation’s foreign exchange risk. Discuss the advantages and disadvantages
of each.
6. A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option
on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options
and one put option.

(i) What is the breakeven stock price, above which the trader makes a profit?

(ii) What is the breakeven stock price below which the trader makes a profit?
7. A trader buys 100 European call options (i.e., one contract) with a strike price of $40 and
a time to maturity of one year. The cost of each option is $4. The price of the underlying
asset proves to be $50 in one year. What is the trader’s gain or loss? Show a dollar amount
and indicate whether it is a gain or a loss.
8. A trader sells 100 European put options (i.e., one contract) with a strike price of $100 and
a time to maturity of six months. The price received for each option is $8. The price of the
underlying asset is $82 in six months. What is the trader’s gain or loss? Show a dollar
amount and indicate whether it is a gain or a loss.
9.
(a) Alice purchased a put option on British pounds for $.04 per unit. The strike price was $1.80
and the spot rate at the time the pound option was exercised was $1.59. Assume there are
31,250 units in a British pound option. What was Alice’s net profit on the option?

(b) Brian sold a put option on Canadian dollars for $.03 per unit. The strike price was $.75,
and the spot rate at the time the option was exercised was $.72. Assume Brian immediately
sold off the Canadian dollars received when the option was exercised. Also assume that
there are 50,000 units in a Canadian dollar option. What was Brian’s net profit on the put
option?

Common questions

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The investor makes a profit if the stock price falls below $40 by an amount greater than $3 (the cost of the option) at maturity. For example, if the stock price is $36, the investor's profit would be $1. The put option is exercised when the stock price is less than $40 .

The trader realizes a gain when the maturity stock price exceeds $44, which covers the strike price ($40) and the option cost ($4). With the stock price at $50, the intrinsic value of each option is $10, resulting in a total profit of $600 [(100 options x ($10-$4))].

An investor's profit from the put option increases as the stock price decreases below $52 (strike price $60 minus premium $8). The option is exercised if the stock price at maturity is less than $60. The profit is zero or losses occur if the stock price is above $60 by more than the premium paid .

For the call options, the trader breaks even above a stock price of $36 (sum of strike price and cost of options). For the put option, the profit is realized when the stock price is below $26 (strike price minus cost of options). Thus, the break-even points are $36 for calls and $26 for puts .

The seller incurs a loss if the stock price falls below $92 at maturity because the option will be exercised, and the seller will need to pay the difference between the $100 strike price and the maturity price of $82, less the premium received, which results in a loss of $10 per option, totaling $1,000 for 100 options .

Options provide the benefit of limited loss to the premium paid, offering flexibility not to exercise the option if the market moves unfavorably, which contrasts with forwards that impose the obligation to transact. However, options can be more expensive due to premiums, while forwards, being binding agreements, may offer a better cost structure for those looking for definite hedge certainty, albeit with different risk profiles .

The seller of the call option makes a profit if the stock price remains below $50 at maturity, ensuring that the option is not exercised. The maximum profit is the premium received, which is $4. The option will be exercised if the stock price exceeds $50, potentially resulting in a loss for the seller depending on the premium amount .

The holder of the call option makes a profit if the stock price exceeds $105 at maturity. This price covers the strike price ($100) and the cost of the option ($5). The option will be exercised if the stock price is above $100 .

Alice's net profit depends on the difference between the strike price ($1.80) and the spot rate at exercise ($1.59), minus the premium paid ($0.04). With 31,250 units, the intrinsic value of the option is $6,562.50, and after subtracting the total premium of $1,250, her net profit is $5,312.50 .

Brian incurs a cost of $1,500 due to the need to buy the Canadian dollars at the strike price of $0.75 and sell at the spot rate of $0.72, losing $0.03 per unit. With 50,000 units, this loss is offset by the premium received of $0.03 per unit, resulting in a net zero financial outcome .

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