Question

3. Call options are available with strike prices of $15, $17 ½ and $20 at prices of $4, $2, and $0.5. Consider a butterfly spread. (BUY X₁, SELL 2X2 and BUY X3 where X2=(X1 + X3)/2 & X2 S)

A. What are the breakeven stock prices for this trade?

B. What are the stock prices that make this a profitable trade?

[The correct answer is not 19.50 or 19.00 for the lower bound, it is 15.50]

4.The current price of a stock is $94 & European call options with a strike of $95 currently sell for $4.70. An investor is trying to decide between buying 100 shares of stock and buying 2,000 call options (= 20 option contracts).

A. At what stock price would the investor be indifferent between these 2 trades?

B. At what stock prices would the investor be better off with the option contract purchase?

Answer 1

Question 3)

Strike Price : $15, Premium = $4

Strike Price: $17.5, Premium = $2

Strike Price: $20, Premium = $0.5

In the butterfly spread we will buy the call optioon of $15 and $20 and sell 2 call option of strike $17.5

Net investment = Premium received in selling the call option -Premium paid in buying call opions

Net investment = 2*2 -4-0.5 = -0.5

Part A )

Break-even point of butterfly strategy: There will be two breakeven point in this strategy and the lower breakeven point will be the lowest strike price + net debit

Lower Breakeven point = $15 + 0.5 = $15.5

Higher Breakeven point = Highest strike price - Net debit = 20 - 0.5 = 19.5

Part B )  What are the stock prices that make this a profitable trade?

If the stock price is between 15.5 and 19.5 then this strategy will yield profit.

As per guildeline I have answered one question, Kindly post other question separately.