An investor has $19,000 to invest and believes that the IBM stock price is going to increase in the following 12 months from the current stock price of $200. Call options on IBM stock expiring in 12 months have a strike price of $207 and sell at a premium of $20 each. Assume that the stock price will be $268 per share after 12 months.

a. What will be the investor's rate of return if they buy 450 call options?

b. What will be the investor's rate of return if they buy 45 shares?

a. 305%

b. 34%

Explanation:

If 450 options were bought, the investor would have invested just the amount paid for the options which is $9,000 ($20*450).

On exercising the option, the investor would gain per share the excess of market price over the option exercise price i. e 450 * ($268-$207) = $27,450.00

return on investment = 27,450/9000=305%

If the investor had bought the shares he would invested $9000 ($200*45)

By selling the shares for $268 return would $3,060 ($268-$200) * 45

return on investment=$3,060/$9,000=34%