Question

Assume that you have shorted a call option on Intuit stock with a strike price of $31; when you originally sold (wrote) the option, you received $5. The option will expire in exactly three months' time.

a. If the stock is trading at $ 36 in three months, what will your payoff be? What will your profit be?

b. If the stock is trading at $ 25 in three months, what will your payoff be? What will your profit be?

c. Draw a payoff diagram showing the amount you owe at expiration as a function of the stock price at expiration.

d. Redo (c), but instead of showing payoffs, show profits.

Answer #1

Hello,

Here is the solution -

a) Payoff = initial option price – MAX ( 0 , underlying price – strike price ) = $5 - MAX(0,$36 -$31) = $5 - $5 = 0 . Hence there is no profit no loss

b) Payoff = initial option price – MAX ( 0 , underlying price – strike price ) = $5 - MAX(0,$25 -$31) = $5 - $0 = $5 Hence there is profit of $5

c) Payoff digram -

d)

The red line is the profit line

Th blue line is the payoff line

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