Suppose you think FedEx stock is going to appreciate substantially in value in the next year. Say the stock's current price, S0, is $100, and the call option expiring in one year has an exercise price, X, of $100 and is selling at a price, C, of $10. With $10,000 to invest, you are considering three alternatives:
a. Invest all $10,000 in the stock, buying 100 shares.
b. Invest all $10,000 in 1,000 options (10 contracts).
c. Buy 100 options (one contract) for $1,000 and invest the remaining $9,000 in a money market fund paying 4% interest annually.
What is your rate of return for each alternative for four stock prices one year from now? Summarize your results in the table and diagram below.
In terms of dollar returns:
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Price of Stock 1 Year from Now
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$80
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$100
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$110
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$120
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a. All stocks (100 shares)
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b. All options (1,000 shares)
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c. Bills + 100 options
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In terms of rate of return on investment, based on a $10,000 investment:
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Price of Stock 1 Year from Now
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$80
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$100
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$110
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$120
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a. All stocks (100 shares)
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b. All options (1,000 shares)
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c. Bills + 100 options
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