Seth Harris is an avid investor who likes to speculate on stock price changes. Lately, he's become bored with the slow movement of of most stocks and thinks options might be more exciting. He has been following the stock of Chelsea Club, Inc., a women's apparel manufacturer. Chelsea's stock price has been stable for more than a year, but Seth is convinced it will increase in the near future but not rapidly.
Amanda Johnson owns 1,000 shares of Chelsea Club, purchased a year ago at $37. She thinks the stock's price will continue in the upper $30's indefinitely and may fall a little. Her broker has recommended writing options as a source of income on stagnant stocks.
Chelsea Club is selling for $38, and six-month call options at a $36 strike price sell for $4. This morning, Amanda wrote call options on her 1,000 shares, which Seth bought through an options exchange.
At the time of the transaction:
a. What was the intrinsic value of an option?
b. What was the option's time premium?
c. What was the call in or out of the money?
d. How much has Amanda invested?
e. What is the most Seth can make or lose?
f. What is the most Amanda can make or lose?
It's almost six month later. Chelsea Club is selling for $44. Amanda's options are about to expire and Seth exercises.
g. What is Seth's profit or loss?
h. What is Amanda's profit or loss?
i. Does Amanda incur an "opportunity loss"? If so, how much is it?
j. What would Amanda's profit or loss have been if her call had been written naked?