Question

Draw the payoff diagram for the following position: (i) long one 25-strike call, (ii)short two 30-strike calls, (iii) long one 35-strike call. Assume all options have the sameunderlying and the same time to expiration. Be sure to label the axes of your graph.Briefly explain how these options combine to form the payoff diagram that you drew

Answer 1

Call Option:
Holder of call option will have right to buy underlying asset at the agreed price ( Strike Price). As he is receiving right, he needs to pay premium to writer of call option.He will exercise the right, when expected spot price > Strike Price. Then writer of option has to sell at the strike Price.

First Call :

Our Position - Holder

Qty - 1

We will not exercise the option until it reaches 25. AFter 25, Each 1$ inc in future price will lead to 1$ increase in Payoff.

Second Call:

Our Position - Writer.

Holder of option will not exercise the option until it reaches 30. AFter 30, Each 1$ inc in future price will lead to 1$ Decrease in Payoff.

As we have written two options, Value shall be multiplied with 2

Third Call:

We will not exercise the option until it reaches 35. AFter 35, Each 1$ inc in future price will lead to 1$ increase in Payoff.

FSP	VC ( Strike Price 25)	Vc ( Strike Price 30) - 2 Options	Vc (Strike Price 35 )	Total Payoff
$   15.00	$                              -	$                                                   -	$                             -	$               -
$   20.00	$                              -	$                                                   -	$                             -	$               -
$   25.00	$                              -	$                                                   -	$                             -	$               -
$   30.00	$                         5.00	$                                                   -	$                             -	$           5.00
$   35.00	$                       10.00	$                                           -10.00	$                             -	$               -
$   40.00	$                       15.00	$                                           -20.00	$                         5.00	$               -
$   45.00	$                       20.00	$                                           -30.00	$                      10.00	$               -
$   50.00	$                       25.00	$                                           -40.00	$                      15.00	$               -

Payoff Diagram:

X - Axis : Future Spot Price

Y- Axis = Payoff