Question

An investor purchases 100 shares of stock for $20 per share. The stock has now risen in price to $44 per share. To cover potential losses, the investor purchases a put option for a premium of $300 with an exercise price of $42 per share. The stock falls to $28 per share, and the investor exercises the option and sells the shares at $42 per share. Ignoring brokerage commissions and taxes, what would be the investor's return from the stock?

A) 120%
B) 110%
C) 95%
D) 70%

Answer 1

The investor's total profit is $1900 after considering the initial investment and the put option cost, which gives a percentage return of 95%. Thus, the investor's return from the stock would be 95%, matching option C).

Step-by-step explanation:

The investor's return from the stock can be calculated by considering the initial investment, the sale proceeds from exercising the put option, and the cost of the put option premium.

Initial investment is the purchase of 100 shares at $20 per share:

• Initial Investment = 100 shares x $20/share = $2000

Sale proceeds from exercising the put option (100 shares at the exercise price of $42 per share):

• Sale Proceeds = 100 shares x $42/share = $4200

Cost of the put option premium:

• Put Option Premium = $300

Total Profit = Sale Proceeds - Initial Investment - Put Option Premium

Total Profit = $4200 - $2000 - $300 = $1900

To calculate the percentage return, we divide the Total Profit by the Initial Investment:

Percentage Return = (Total Profit / Initial Investment) x 100

Percentage Return = ($1900 / $2000) x 100

Percentage Return = 95%

Therefore, the investor's return from the stock would be 95%, which corresponds to option C).