You have $100 to invest. You can invest it in one of two alternatives. The first is to invest it in a stock that is trading for $100. The second is to buy three-month 100-strike calls on the stock that are currently trading at $4 each. You expect the stock price to appreciate with a maximum price after three months of $110. What is the maximum return on investment you can generate using stock and options?

Question

Quizplus · Accepted Answer

- If you invest all $100 in the stock, and the stock price increases to $110, then your return on investment is: (110-100)/100 = 10%.
- If you buy three-month 100-strike calls on the stock, each costing $4, then you can buy 25 calls with $100 ($100/($4 x 25) = 100/100). Each call option gives you the right to buy one share of the stock at $100 within the next three months. If the stock price increases to $110, then each call option is worth: max(0, 110-100) = $10. Therefore, your return on investment is: (25 x $10 - $100)/$100 = 150%.
Thus, buying three-month call options is the better choice as it gives a higher potential return on investment.

You Have $100 to Invest