Question

You observe a stock is priced at $165. This stock’s option expirations are July 15, August 20 and October 15. The risk-free rates associated with the option expirations are 5 percent, 5.35 percent and 5.7 percent. The standard deviation is 21 percent. The stock’s option prices are stated in the table below.

	Calls			Puts
Strike	Jul	Aug	Oct	Jul	Aug	Oct
160	6.00	8.10	11.10	0.75	2.75	4.50
165	2.70	5.25	8.10	2.40	4.75	6.75
170	0.80	3.25	6.00	5.75	7.50	9.00

Required:

(a)    Construct a bear spread using October calls.                            

(b)    Determine the profits for the holding period indicated if the stock price is at $150, $155, $160, $165, $170, $175 and $180 at the end of the holding period. Plot a graph for this result.                                                        

(c)    Compute the breakeven stock price at the expiration.               

(d)    Identify the maximum and minimum profit.                                

(e)    Justify your answers above.                                                     

                                                                                                      

Answer 1

A). Bear call October spread.

• Buy the call with the higher exercise price. I.e. $170 with premium of $6.
• Sell the call at lower exercise price.i.e. $160 with premium of $11.1

Profit:- $4.1($11.1 - $6)

B). Refer the image-

C). Break even point= stike price of net call + net premium

= 160+ 4.1 = 164.1

D). maximum profit = net premium = 4.1

Minimum loss = Difference between strike prices of calls (i.e. strike price of long call less strike price of short call) + Net Premium)   

= (160-170) + 4.1 = -5.9