You would like to speculate on a rise in the price of a...

You would like to speculate on a rise in the price of a certain stock. The current stock price is $$\$ 29$$ and a 3 month call with a strike price of $$\$ 30$$ costs $$\$ 2.90$$. You have $$\$ 5,800$$ to invest. Identify two alternative investment strategies, one in the stock and the other in an option on the stock. What are the potential gains and losses from each?

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Key Concepts

Long Stock Investment

Investing directly in the stock involves buying shares at the current market price, thereby gaining full exposure to any variations in the stock’s value. This strategy means that profits are realized as the stock price rises, while losses occur if the stock falls. The gains or losses are proportional to the number of shares held, and the investor’s capital experiences full exposure to the underlying asset’s performance over time.

Call Option Speculation

Purchasing call options gives an investor the right, but not the obligation, to buy the stock at a predetermined strike price within a certain period. This approach offers leverage, as a relatively small investment—known as the option premium—controls a larger amount of stock. The potential gain is higher percentage-wise if the stock moves significantly above the strike price, while the maximum loss is limited to the premium paid, which helps in managing downside risk compared to owning the stock outright.

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