Question text 4Marks One year ago, you bought an American call option with a strike price of $40 for $3.50. The underlying stock is now trading for $35 in the market. Given the above scenario, what will be your net profit/loss and holding period return if you decide not to exercise the option? Your net profit/loss is: Answer 4[select: , -$5, -$1.95, -$3.50, $2.05, $8.50] Your Holding Period Return (HPR) is: Answer 5[select: , 22.45%, 63.93%, 83.91%, 45.33%, None of the above] Notes Report question issue Question 6 NotesMultiple fill-in-the-blank
Log in for full answers
We've collected over 50,000 authentic original questions and detailed explanations from around the globe. Log in now and get instant access to the answers!

Question

Question text 4Marks One year ago, you bought an American call option with a strike price of $40 for $3.50. The underlying stock is now trading for $35 in the market. Given the above scenario, what will be your net profit/loss and holding period return if you decide not to exercise the option? Your net profit/loss is: Answer 4[select: , -$5, -$1.95, -$3.50, $2.05, $8.50] Your Holding Period Return (HPR) is: Answer 5[select: , 22.45%, 63.93%, 83.91%, 45.33%, None of the above] Notes Report question issue Question 6 NotesMultiple fill-in-the-blank

Log in for full answers

We've collected over 50,000 authentic original questions and detailed explanations from around the globe. Log in now and get instant access to the answers!

BlackTom AI · Accepted Answer

An American call with strike $40 is out-of-the-money because the current stock price $35 is below the strike, so exercising would not be beneficial. The option’s value at expiration (or if you choose not to exercise now) is zero, so your loss equals the premium you paid.

1) Relevant knowledge points and concepts
- Payoff of a call at expiration: max(ST − K, 0).
- Net profit/loss for a long option = payoff − premium paid.
- Holding Period Return (HPR) = (net profit or loss) / initial cost (premium).
- An American call that is out-of-the-money should not be exercised; its payoff is 0.

2) Step-by-step reasoning and calculations
- Given: K = $40, ST = $35, premium = $3.50.
- Call payoff = max(35 − 40, 0) = max(−5, 0) = 0.
- Net profit/loss = payoff − premium = 0 − 3.50 = −$3.50.

3) Intermediate steps for HPR
- HPR = (net profit or loss) / initial cost = (−3.50) / 3.50.
- HPR = −1 = −100%.

4) Why the correct answer is correct
- Because the option is worthless at current market price, you lose the entire premium you paid. That loss divided by the premium gives −100% holding period return.

5) Why the other multiple-choice percentage options are incorrect
- 22.45%, 63.93%, 83.91%, and 45.33% are all positive percentages and none equal −100%. They stem from incorrect formulas or arithmetic mistakes (e.g., comparing stock price changes instead of option payoff), so they do not represent the true HPR here.

6) Conclusion
- Net profit/loss: −$3.50. HPR: −100% (so the correct selection among the given options is “None of the above”). This matches the provided answers: "-$3.50" and "None of the above".