Question

Question Number 1

Due to the bullish trend of the market in underlying stock of option which is trading at $75. Based on the market estimate you opt for one call option with strike price of $70 and selling at $7.5, and one short call option with a strike price of $80 and selling at $3. The expiration on both cases is 6 months.

A. What strategy you have adopted under this scenario explain?

B. Determine the position value at the expiation and the profit when stock price is $79,

$88, and $70

Question Number 2

Opting the strategy of box spread which consist of options on a stock with price of $28.86.

The options have strike prices of $26 and $3.25, and they mature in three months. Any position in call option for the strike prices of $24 and $31 have a premium of $4.90 and $3.10, respectively. Similarly, any position in put option have a premium of $3.00 and $3.90, respectively. In this scenario what should be the risk-free rate be in order to make the option aligned with market setting or price correction?

Answer 1

1-A). The strategy of buying a call option and shorting a call option with a higher strike price is known as a bull call spread. In this strategy, losses are limited but gains are also capped.

1-B). Payoff of the bought call option (P1) = max(stock price - exercise price , 0)

Profit of the bought call option (Pr1) = Payoff - option price

Payoff of the shorted call option (P2) = -max(stock price - exercise price , 0)

Payoff of the shorted call option (Pr2) = Payoff + option price

Total payoff (P) = P1 + P2

Total profit (Pr) = Pr1 + Pr2

Stock price = 79

P = max(79-70,0) -max(79-80,0) = 9 -0 = 9

Pr = 9 - 7.5 + 3 = 4.5

Stock price = 88

P = max(88-70,0) -max(88-80,0) = 18 - 8 = 10

Pr = 10 - 7.5 + 3 = 5.5

Stock price = 70

P = max(70-70, 0) -max(70-80,0) = 0

Pr = 0 -7.5 + 3 = -4.5