If you anticipate that the price of the stock will rise, you could (1) buy the stock, (2)

timer Asked: Dec 21st, 2014

Question description

If you anticipate that the price of the stock will rise, you could (1) buy the stock, (2) buy a call, (3) sell the covered call, or (4) sell the put. All four positions may generate profits if the price of the stock rises, but the cash inflows or outflows, the amount of any gains, and the potential losses differ for each position. Currently, are trading for $10.50 and $8.25, respectively. 

A) What are the cash inflows or outflows associated with each of the four positions?

B) construct a profit/loss profile for each at the following prices of the stock


Price of the stock Bought the stock Covered Call Bought the call sold the Put











As this profile illustrates, each strategy produces a gain but the amounts and potential losses differ

C) what are the prices of the stock that generate breakeven for each position?

D) Compare the cash inflows/outflows, profits, and potential loss from the covered call and sale of the put. Which is better if you are able to invest any cash inflows and earn$1.25?

E) Which strategy has the smallest potential dollar loss?

F) What price of the stock produces a loss on all four positions?

G) Which position generates he highest possible gain in dollar and in percentage terms?

H) suppose the price of the stock declines, and the put is exercised (i.e, you have to buy the stock). Since the option is exercised, what is your cost basis of the stock? Compare this cost basis to your initially buying the stock instead of selling the put.

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