Question

ABC company's financial manager buys call options on 57 000 barrels of oil with an exercise price of $97 per barrel. She simultaneously sells a put option on 57,000 barrels of oil with the same exercise price of $97 per barrel Ignore the costs of the options and all transaction costs. What is abc's profit or loss on these two option contracts if market price of oil is $95 per barrel at expiration

A 0, as her position is completely hedged

B Loss of $114,000
C Loss of $20,000
D Profit of $20,000
E Profit of $114,000

Answer 1

B) loss of $114,000

Explanation: The investor buys call option and sells put option. A call option is exercised, when the stock price is more than exercise price. Where as a put option is exercised, when exercise price is more than stock price.

In this case, the call option is not exercised as the stock price (95) is less than exercise price (97). So, profit from call option is 0.

And the put option in this case is exercised because the exercise price (97) is more than stock price. As, we are selling the put option in this case , we will be making a loss.

Loss = - Max (0, 97 - 95) × 57,000

= - Max (0, 2) × 57,000

= -2 × 57,000

= ($114,000)