CFA Level I · CFA Level I Exam · Forward Commitment and Contingent Claim Features and Instruments
An investor buys a European call option on a share with an exercise price of 50 for a premium of 3. At expiration the share trades at 58. The investor's profit on the long call, ignoring financing costs, is closest to:
The profit is 5. The call pays 58 minus 50, which is 8 at expiration, and the buyer paid a premium of 3 up front, so net profit is 8 minus 3, or 5. Adding the premium instead of subtracting it is the common error.
- A5Correct
- B8
- C11
Explanation
The payoff at expiration is max(0, 58 - 50) = 8. Profit equals payoff minus premium paid: 8 - 3 = 5. The value 8 ignores the premium, and 11 wrongly adds the premium to the payoff.
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