Problem: Allen has been investing in the stock market for quite some time and had some success with equity investments. Recently, a friend suggested that he start to use options in his portfolio as a means to increase his returns. Allen decided to purchase a March, 2009 expiration call option on Stock X, which carried an exercise price of $500 that was selling for $15. Two weeks later, shares of Stock X were trading for $480.6. Now that the stock price is lower than the purchase price, the options are worthless. However, when Allen waited an additional two weeks, the stock price climbed to $510. Allen, feeling a bit of anxiety, decides to exercise the option and realize some gains.
1) In exercising this option, what price is Allen getting the stock for?
2) What is the value at exercise of the option?
3) Calculate the profit or loss on this transaction.
4) How might Allen have covered this position to limit his exposure?
5) How might you use calls like this to increase an investments performance?