An investor is considering buying 500 shares of ABC Company at $32 per share. Analysts agree that the firm's stock price may increase to $45 per share in the next 4 months. As an alternative, the investor could purchase a 120-day call option at a striking price of $30 for $5,000. At what stock price would the investor break even?

Question

Quizplus · Accepted Answer

If the investor buys 500 shares at $32 per share, the total investment cost will be:
500 shares x $32 per share = $16,000

If the stock price increases to $45 per share, the investor will make a profit of:
500 shares x ($45 - $32) per share = $6,500

Alternatively, if the investor buys a call option for $5,000, the total investment cost will be:
$5,000

To break even, the stock price needs to increase enough to cover the cost of the call option. This means the stock price needs to be at least:
$30 (strike price) + $5 (cost of option) = $35

Therefore, the investor would break even at a stock price of $35 when purchasing the call option. However, if the stock price increases to $40 or beyond, the investor would make a larger profit with the call option than by purchasing the stock outright.

An Investor Is Considering Buying 500 Shares of ABC Company