Question

Set-up for all parts: An investment strategy involves four stock options with the same expiration date but different strike prices. An example is the following: (i) write a call option with strike price 60, (ii) buy a call option with strike price 55, (iii) buy a put option with strike price 45, and (iv) write a put option with strike price 40.

OPTION STRATEGY (PART 1)

Using the table below, express the total payoffs of this strategy in terms of the price S_T. Please fill up the total payoff of this strategy in the bottom row of the table.

Instructions: If some of your payoffs are related to S_{T ,} denote S_T as S in your answer. That is, if the payoff is for example 10-S_{T ,} please type in "10-S" (no spaces between the characters).

A)

	0<ST< 40	40< ST < 45	45< ST < 55	55< ST < 60	60< ST
Write Call
Buy Call
Buy Put
Write Put
Total Payoff

B)

C) For which values of S_T will the strategy make the highest profit?

1-

0-40

2-

4--45

3-

45-55

4-

55-60

5-

60+

Answer 1

		0<ST< 40	40< ST < 45	45< ST < 55	55< ST < 60	60< ST
Strike price 60	Write Call	0	0	0	0	60-S
Strike price 55	Buy Call	0	0	0	S-55	S-55
Strike price 45	Buy Put	45-S	45-S	0	0	0
Strike price 40	Write Put	S-40	0	0	0	0
	Total Payoff	5	45-S	0	S-55	5

C)

At

1) 0-40 and 5) 60+ we have the highest profit = 5

Even in 40-45 we can have highest profit when S=40 and in 55-60 when S=60