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**CFA Practice Question**

A trader owns an American call option has a strike price of $200. The current stock price is $220. The option has 3 months to expiry. The riskless rate for 3 months is 2% (not annualized). The trader is allowed to go both long and short of stocks, options, and bonds (both borrow and lend at the riskless rate). Transactions costs are zero. What is the maximum cash flow the trader can generate today (arising from ownership of the American call option) while keeping all future cash flows non-negative?

A. 23.92

B. 20

C. 28.32

**Explanation:**While keeping future cash flows non-negative, the trader generates maximum cash flows today by shorting a stock, and going long bonds with maturity value equal to strike price. This gives the trader $220 - ($200/(1+0.02)) = $23.92

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**User Contributed Comments**
2

User |
Comment |
---|---|

harrybay |
Why has the maturity value of the bond to be equal to the strike price? |

jlai1990 |
Harrybay -> it is so that is finances the purchase of the stock which is 200 |