Question

13. Stock ABC is trading at $51. Three-month calls with an exercise price of $55 are trading at $3.
Three-month put options with an exercise price of $45 are trading at $2.
a. If you sell both options, are you expecting the stock to be volatile over the next three months?
b. If you sell both options, what is the range of stock prices in which you make money?
c. What is your biggest risk if you sell both options?

Answer 1

a

Selling call option indicates that investor expecting stock price to go up.

Selling put option indicates that investor expecting stock price to go down.

By selling both options investor expecting stock prices to be volatile

b

If stock price stays below $55 call is in the money for writer. If stock price stays above 45 put option is in the money.

Thus, range is 45 to 55

c

Total premium received is $5

If stock price goes above = 55+5 = 60

or below = 45-5 = 40

Then it is a concern as it will start incurring losses.