Suppose you think Wal-Mart stock is going to appreciate substantially in value in the next year. Say the stock’s current price, S 0 , is $100, and the call option expiring in one year has an exercise price, X, of $100 and is selling at a price, C, of $10. With $10,000 to invest, you are considering three alternatives:
a. Invest all $10,000 in the stock, buying 100 shares.
b. Invest all $10,000 in 1,000 options (10 contracts).
c. Buy 100 options (one contract) for $1,000 and invest the remaining $9,000 in a money market fund paying 4% interest annually. What is your rate of return for each alternative for four stock prices one year from now? Summarize your results in the table and diagram below.