Question

The common stock of the C.A.L.L. Corporation has been trading in a narrow price range around $50 per share for months, and you believe it is going to stay in that range for the next three months. The price of a 3-month put option with an exercise price of $50 is $4.

c) How can you create a position involving a put, a call and riskless lending that would have the same payoff structure as the stock at expiration? What is the net cost of establishing that position now?

Answer 1

Solution

The strategy is to create a position having a similar payoff structure as the stock gets inclusive of a call, a put, and riskless lending in the stipulated portfolio. Thus, the strategy is framed as

• Purchase the call;

• Write the put; and

• Lend the current value of $50.

Through this strategy, the following payoff represented in the below table is obtained:

The initial outlay here equals the present value (PV) of $50 plus $3 .

In either case, the payoff will be the same even if the stock is bought.