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
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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

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BlackTom AI · Accepted Answer

Intrinsic value of the call is max(S − K, 0) = max(35 − 40, 0) = 0, so the option is out-of-the-money and worthless at expiration (or if you choose not to exercise it now).

1) Relevant concepts
- Call option payoff at exercise = max(S − K, 0). For an American call you may exercise anytime, but rational exercise occurs only if payoff > 0.
- Net profit/loss for an option buyer = payoff at exercise (or resale value) − premium paid.
- Holding Period Return (HPR) = (Ending value − Initial cost) / Initial cost.

2) Step-by-step reasoning
- Stock price now S = $35, strike K = $40 => intrinsic payoff = max(35 − 40, 0) = 0.
- Since payoff = 0, exercising would require paying $40 to buy a $35 stock (loss of $5) — so exercising is irrational. The option will be allowed to expire worthless (or sold for zero in this scenario).
- You originally paid premium = $3.50 for the call one year ago.

3) Calculations (all intermediate steps)
- Payoff = 0.
- Net profit/loss = payoff − premium = 0 − $3.50 = −$3.50.
- HPR = (Ending value − Initial cost) / Initial cost = (0 − 3.50) / 3.50 = −3.50/3.50 = −1 = −100%.

4) Why the correct answer is correct
- The option has no intrinsic value because the strike exceeds the market price; the buyer loses the entire premium paid. That equals a $3.50 loss, which is a −100% return on the $3.50 investment.

5) Why the other multiple‑choice percentages are incorrect
- The listed percentages (22.45%, 63.93%, 83.91%, 45.33%) are all positive and none equal −100%. They do not represent the (0 − 3.50)/3.50 result, so they are incorrect.

6) Conclusion
- Net profit/loss = −$3.50. Holding Period Return = −100%, so from the available choices the correct HPR selection is “None of the above.” This matches the provided answers: -$3.50 and None of the above.

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