Question

A Stock trades for $100. Interest rates for a year are 2%. Calls maturing in a year with exercise prices of $90, $95, $100, $105, and $110 trade at prices of $17, $14, $11, $9, and $7 respectively. Puts maturing in a year with exercise prices of $90, $95, $100, $105, and $110 trade at prices of $4, $6, $8, $11, and $14 respectively. Explain with reasons what option based trading strategies you will use if you expect the end of year price to be between $90 and $95. Write a short answer

Answer 1

We expect the prices to stay in between 90 and 95.

We sell a call with strike price of 95 and receive 14 also we sell put option with strike price of 90 and receive 6.

In all on the day on transaction we receive 20

On the day of expiry

Value of Call at expiration = Stock Price (S)- Strike Price (X) (Where S> X) or 0 (Where X < equal to S)

Value of Put at expiration = Strike Price (X) - Stock Price (S) (Where X < S) or 0 (Where S>equal to X)

So value of call is expected to be zero as we expect the prices to not move beyond 95

Also value of put is expected to be zero as we do not expect the prices to move below 90.

Hence if the share prices stay in between 90 and 95 we have earned a profit of 20