NASAA Series 66 Uniform Combined State Law ExaminationInvestment Vehicle CharacteristicsHard
A client has purchased a 3-month European call option on ABC stock with a strike price of $50 for a premium of $2. The current market price of ABC stock is $51. At expiration, the ABC stock price is $55. What is the client's profit or loss from this option contract, assuming 100 shares per contract?
- AProfit of $200.
- BLoss of $200.
- CProfit of $300.
- DProfit of $500.
Show answer & explanationAnswer & explanation
Correct answer: C. Profit of $300.
The call option allows the client to buy ABC stock at $50. At expiration, the stock is at $55, so the option is in-the-money by ($55 - $50) = $5 per share. The gross profit from exercising is $5 * 100 shares = $500. After subtracting the premium paid ($2 * 100 shares = $200), the net profit is $500 - $200 = $300.
Why the other options are wrong
- A. This incorrectly calculates the profit, possibly by subtracting strike from current price and then the premium, but with an error in the intrinsic value calculation.
- B. This would be the loss if the option expired worthless and the premium was lost, which is not the case here.
- D. This is the gross profit from the option's intrinsic value, without accounting for the premium paid.
Call Option Profit/Loss
For a call option buyer, profit occurs when the underlying asset's price at expiration is above the strike price plus the premium paid. Loss is limited to the premium paid if the option expires out-of-the-money.
- Breakeven point = Strike Price + Premium.
- Intrinsic value = Market Price - Strike Price (if positive).
- Profit = (Intrinsic Value - Premium) * Shares per contract.
Memory trick: Call options: if the price 'calls' higher, you profit, after paying the 'price'.