Problem:
You strongly believe that the price of Breener Inc. Stock will rise substantially from its current level of $137, and you are considering buying shares on the company. You currently have $13,700 to invest. As alternaltive to purchasing the stock itself, you are also considering buying call options on Breener stock that expire in three months and have an exercise price of $140.00. These call options cost $10 each.
1) Compute and contrast the size of the potential payoff and the risk involved in each of these alternatives.
2) Calculate the three month rate of return on both strategies assuming that at the option expiration date Breeener's stock price has (1) increased to $155 or(2) decreased to $135.
3) At what stock price level will the person who sells you the Breener call option breakeven? Can you determine the maximum loss that the call option seller may suffer, assuming that he does not already own Breener Stock?