Question

You take a speculative position in two options. You buy a call option and you buy a put option on firm XYZ The call option has a strike price of $50 and you pay a premium of $4. The put option also has a strike price of $50 and you pay a premium of $4. Both options expire at the same time in three months from now.

1. You are betting that the stock price of XYZ:

A) Will remain fairly constant B) Will increase by a large amount C) Will decrease by a large amount D) Will move by a large amount in either direction

2. What is your maximum possible profit?

A) Unlimited B) $50 C) $42 D) $58 E) $8

3. Assume at expiration that ABC’s stock price equals $60. Your profit or loss equals:

A) A loss of $8 B) A loss of $4 C) A loss of $2 D) A profit of $2 E) A profit of $8

Answer 1

Call option is the right to buy the underlying asset at a specified price on a future date while put option is the right to sell the underlying asset at a specified price.

1.D) Will move by a large amount in either direction

Since the position is taken on both call and put, one will be exercised on change, the other will be allowed to lapse to make a profit

2)A)Unlimited

Since the stock price can rise to any extent

3)Call option will be exercised while put will be allowed to lapse

Profit = (60-50-4-4)

= $2

D) A profit of $2