Question

1. An investor sells a European call option with strike price of E and maturity and buys a put with the same strike price and maturity on the same underlying asset. a. Create a payoff table of this position at expiration b. Show this payoff on a graph

Answer 1

a]

If the price of the underlying at expiry is below E :

The put option will have a payoff equal to (E - underlying price at expiry). This is because the put option can be exercised by the investor for a profit

The call option will have a payoff equal to zero. This is because the buyer of the option will not exercise the option if the underlying price at expiration is below the strike price

If the price of the underlying at expiry is above E :

The call option will have a payoff equal to (E - underlying price at expiry). This is because the buyer of the option will exercise the option if the underlying price at expiration is above the strike price

The put option will have a payoff equal to zero. This is because the investor will not exercise the option as it not profitable to do so

If the price of the underlying at expiry is equal to E, both options will have a payoff equal to zero

The payoff table is as below :

b] Payoff graph is below :