Question

You purchased the following portfolio a year ago: long one stock of London XYZ plc for 25.35GBP, short one call option on the stock with a strike price of 27 GBP, a maturity of one year with a price of 3 GBP and long one put option on the stock with a strike price of 23 GPB, a maturity of one year with a price of 3 GBP. The price of London XYZ plc is 21.24 GBP today. Calculate the gross payoff at maturity and the realized rate of return of the portfolio.

Answer 1

1. Long Stock @ 25.35
2. Short 1 call option. Strike 27, Premium received = 3
3. Long 1 Put Option . Strike 23, Premium Paid = 3

Now, at the maturity, Closing Value is 21.24

1. Long Stock will give loss as Price has fallen. Loss = 25.35 - 21.24 = 4.11 Loss
2. Short Call option will not be exercised by the buyer, since price fell. Profit of Premium = 3 Profit
3. Long Put will be exercised. Profit / Loss = (23 - 21.24 - 3)** = 1.24 Loss

** Formula used for long Put = Strike Price - Closing Price - Premium Paid

Net Payoff = -4.11 + 3 - 1.24 = -2.35 GBP

Total Amount invested = 25.35 - 3 + 3 = 25.35

Realised Rate of Return = -2.35 / 25.35 = -9.27%

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