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QuestionSmith bought 3,000 shares of ABX at RM0.20, sold 1,000 call options at RM0.20 with a strike price of RM2. If the stock rises to RM3, how much profit does he make when the options are exercised?

Studdy Solution

STEP 1

Assumptions1. Smith bought3,000 shares of ABX Incorporation at RM1.20 each. . He sold1,000 call options at a market price of20 cents each.
3. The strike price of the call option is RM.
4. The stock pays no dividend.
5. The price of the stock rises to RM3 a share.
6. The call option buyer exercises the options.

STEP 2

First, we need to calculate the total cost of the shares Smith bought. We can do this by multiplying the number of shares by the price per share.
Total cost=Number of sharestimesPrice per shareTotal\, cost = Number\, of\, shares \\times Price\, per\, share

STEP 3

Now, plug in the given values for the number of shares and price per share to calculate the total cost.
Total cost=3,000timesRM1.20Total\, cost =3,000 \\times RM1.20

STEP 4

Calculate the total cost of the shares.
Total cost=3,000timesRM1.20=RM3,600Total\, cost =3,000 \\times RM1.20 = RM3,600

STEP 5

Next, we need to calculate the total income from selling the call options. We can do this by multiplying the number of call options by the market price per option.
Total income from options=Number of optionstimesMarket price per optionTotal\, income\, from\, options = Number\, of\, options \\times Market\, price\, per\, option

STEP 6

Plug in the given values for the number of options and market price per option to calculate the total income from options.
Total income from options=1,000timesRM0.20Total\, income\, from\, options =1,000 \\times RM0.20

STEP 7

Calculate the total income from options.
Total income from options=1,000timesRM0.20=RM200Total\, income\, from\, options =1,000 \\times RM0.20 = RM200

STEP 8

Now we need to calculate the total income from selling the shares at the new price. We can do this by multiplying the number of shares by the new price per share.
Total income from shares=Number of sharestimesNew price per shareTotal\, income\, from\, shares = Number\, of\, shares \\times New\, price\, per\, share

STEP 9

Plug in the given values for the number of shares and new price per share to calculate the total income from shares.
Total income from shares=3,000timesRM3Total\, income\, from\, shares =3,000 \\times RM3

STEP 10

Calculate the total income from shares.
Total income from shares=3,000timesRM3=RM9,000Total\, income\, from\, shares =3,000 \\times RM3 = RM9,000

STEP 11

However, Smith sold,000 call options, which means he has to sell,000 shares at the strike price of RM. So, we need to subtract the income from selling these shares at RM from the total income from shares.
Adjusted income from shares=Total income from shares−(Number of optionstimesStrike price)Adjusted\, income\, from\, shares = Total\, income\, from\, shares - (Number\, of\, options \\times Strike\, price)

STEP 12

Plug in the given values to calculate the adjusted income from shares.
Adjusted income from shares=RM9,000−(,000timesRM2)Adjusted\, income\, from\, shares = RM9,000 - (,000 \\times RM2)

STEP 13

Calculate the adjusted income from shares.
Adjusted income from shares=RM9,000−(,000timesRM2)=RM7,000Adjusted\, income\, from\, shares = RM9,000 - (,000 \\times RM2) = RM7,000

STEP 14

Finally, we can calculate Smith's profit by subtracting the total cost from the total income (which is the sum of the income from options and the adjusted income from shares).
Profit=(Total income from options+Adjusted income from shares)−Total costProfit = (Total\, income\, from\, options + Adjusted\, income\, from\, shares) - Total\, cost

STEP 15

Plug in the given values to calculate the profit.
Profit=(RM200+RM7,000)−RM3,600Profit = (RM200 + RM7,000) - RM3,600

STEP 16

Calculate the profit.
Profit=(RM200+RM,000)−RM3,600=RM3,600Profit = (RM200 + RM,000) - RM3,600 = RM3,600Smith's profit is RM3,600.

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