Question
In: Economics
Consider a portfolio consisting of a long position in one stock and a short position in...
Consider a portfolio consisting of a long position in one stock and a short position in two call options. Both the current stock price (S0) and the exercise price (K) of call options are $20. The call option costs $3.
a) Construct a table showing the payoffs and net profits for all possible price ranges.
b) Draw a diagram showing the variation of an investor’s net profit with the terminal stock price
c) For what price range does this portfolio provide a net positive return?
d) What is the maximum amount of profit that can be obtained?
Solutions
Expert Solution
(a)
| Expiry Price | Cashflow | On expiry | Net Cashflow | ||||||
| Stock Buy | Sell 2 Call option | Cashflow Today | Sell Stock | Call Option | Value of Call Option | Value of 2 Option | Cashflow on expiry | ||
| $ 5 | $ (20) | $ 6 | $ (14) | $5 | Lapse | $ - | $ - | $ 5 | $ (9) |
| $ 10 | $ (20) | $ 6 | $ (14) | $10 | Lapse | $ - | $ - | $ 10 | $ (4) |
| $ 11 | $ (20) | $ 6 | $ (14) | $11 | Lapse | $ - | $ - | $ 11 | $ (3) |
| $ 12 | $ (20) | $ 6 | $ (14) | $12 | Lapse | $ - | $ - | $ 12 | $ (2) |
| $ 13 | $ (20) | $ 6 | $ (14) | $13 | Lapse | $ - | $ - | $ 13 | $ (1) |
| $ 14 | $ (20) | $ 6 | $ (14) | $14 | Lapse | $ - | $ - | $ 14 | $ - |
| $ 15 | $ (20) | $ 6 | $ (14) | $15 | Lapse | $ - | $ - | $ 15 | $ 1 |
| $ 16 | $ (20) | $ 6 | $ (14) | $16 | Lapse | $ - | $ - | $ 16 | $ 2 |
| $ 17 | $ (20) | $ 6 | $ (14) | $17 | Lapse | $ - | $ - | $ 17 | $ 3 |
| $ 18 | $ (20) | $ 6 | $ (14) | $18 | Lapse | $ - | $ - | $ 18 | $ 4 |
| $ 19 | $ (20) | $ 6 | $ (14) | $19 | Lapse | $ - | $ - | $ 19 | $ 5 |
| $ 20 | $ (20) | $ 6 | $ (14) | $20 | Indiff. | $ - | $ - | $ 20 | $ 6 |
| $ 21 | $ (20) | $ 6 | $ (14) | $21 | Exercise | $ 1 | $ 2 | $ 19 | $ 5 |
| $ 22 | $ (20) | $ 6 | $ (14) | $22 | Exercise | $ 2 | $ 4 | $ 18 | $ 4 |
| $ 23 | $ (20) | $ 6 | $ (14) | $23 | Exercise | $ 3 | $ 6 | $ 17 | $ 3 |
| $ 24 |
(b)
(c)
Price range between 14 to 26 does this portfolio provide a net positive return. (As we can see in answer of (a) ) (or say price range 14.01 to 25.99 for positive return)
(d)
Maximum Profit can be earn $6 if stock expire at strike price.
Rahul Sunny answered 8 months agoRelated Solutions
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