Question

14.) CALL CORP COMMON STOCK HAS BEEN TRADING IN A NARROW RANGE AROUND $50/ SHARE FOR MONTHS. YOU BELIEVE IT WILL STILL IN THIS RANGE FOR THE NEXT 3 MONTHS. THE PRICE OF A 3 MONTH PUT OPTION WITH AN EXCERCISE PRICE OF $50 IS $4, AND A CALL WITH THE SAME EXPIRATION DATE AND EXCERCISE PRICE SELLS FOR $7.

A.) WHAT WOULD BE A SIMPLE OPTIONS STRATEGY USING A PUT AND A CALL TO EXPLOIT YOUR CONVICTION ABOUT STOCK PRICE'S FUTURE MOVEMENT?

B.) WHAT IS THE MOST MONEY YOU CAN MAKE ON THIS POSITION?

C.) HOW FAR CAN THE STOCK PRICE MOVE IN EITHER DIRECTION BEFORE YOU LOSE MONEY?

D.) HOW CAN YOU CREATE A POSITION INVOLVING A PUT, A CALL, AND RISKLESS LENDING THAT WOULD HAVE THE SAME PAYOFF STRUCUTRE AS THE STOCK AT EXPIRATION? THE STOCK WILL PAY NO DIVIDENDS IN THE NEXT 3 MONTHS

E.) WHAT IS THE NET COST OF ESTABLISHING THAT POSITION NOW?

Answer 1

A) The best strategy to exploit would be to sell the $50 strike option and put both. This is also called as the short straddle strategy.

B) The most money can be made if the stock closes on expiry at $50. Hence the total money made will be = $4 + $7 = $11 .

C) Total premium received in this strategy will be = $4 + $7 = $11 (From selling both the put and call option of strike price $50). Hence if the stock price moves to in any direction upto $11, we wont be losing money. We can say that till the stock price remains from $39 to $61 upon closing, we will not eb losing any money in this strategy.