Question

Q4. A trader longs a European call and shorts a European put option. The options have the same underlying asset, strike price and maturity. Please depict the trader’s position. Under what conditions is the value of position equal to zero? (Hint: compare the payoff pattern of the option position with that of a forward contract.)

Answer 1

Break Even Price for the Position = Strike Price-Premium Received on Writing Put+Premium Paid for Buying Call

When the Price of Underlying at expiry will equal above price, Trader's Position will be 0 i.e. No Profit No Loss.

Cross Verification:

Strike Price = 100, Call Premium = 2, Put Premium = 3

Breakeven = 100-3+2 = 99

If Price at Expiry is 99,

Call will be Lapsed and Loss will be Premium Paid = 1-2 = 2

Put will be Exercised by the Holder and Profit will be (Strike Price-Price at expiry)+Premium Received = (100-99)+3 = 2

Therefore, Net Profit/Loss = 0