Unformatted text preview: eated by the issuing firm. Assume that Cindy Peters pays $250 for a 3-month call option on Wing Enterprises, a maker of aircraft components, at a striking price of $50. This means
that by paying $250, Cindy is guaranteed that she can purchase 100 shares of
Wing at $50 per share at any time during the next 3 months. The stock price
must climb $2.50 per share ($250 100 shares) to $52.50 per share to cover the
cost of the option (ignoring any brokerage fees or dividends). If the stock price
were to rise to $60 per share during the period, Cindy’s net profit would be $750
[(100 shares $60/share) (100 shares $50/share) $250].
Because this return would be earned on a $250 investment, it illustrates the
high potential return on investment that options offer. Of course, had the stock
price not risen above $50 per share, Cindy would have lost the $250 she invested,
because there would have been no reason to exercise the option. Had the stock
price risen to between $50 and $52.50 per share, Cindy probably would have
exercised the option to reduce her loss...
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