Question

A strategy includes three positions: 1) short one share of a stock at 96 per share 2) short one share of put with strike price of 90, a premium is 5.30 per share 3) long one share of call with strike price of 103 and premium of 3.90 per share. Assuming the investor holds the strategy until expiration of the put and the call options.

1. if the market price of the stock is 101 at expiration, the profit from the strategy would be:

2: The maximum profit from the strategy at expiration is:

3: the minumum profit from the strategy at expiration could be:

4. The breakeven price of the strategy is:

Answer 1

1) Cost of Strategy = Premium paid on call - Premium received on Put - Amount received on short share = 3.90 - 5.30 - 96 = (-)97.4

Market price on maturity is 101

On maturity, you will have to purchase the stock at 101 and provide delivery for the short share. The put will not be exercised as market price is greater than the put strike. The call will also not be exercised as market price is less than the call strike.

Therefore, profit = (-)Delivery of stock - Cost of Strategy = (-)101 - (-97.4) = (-)3.60

2) Maximum Gain = (Short sale - strike of Put) + Premium received on Put - Premium paid on call = (96 - 90) + 5.30 - 3.90 = 7.40

3) Maximum Loss = (Call strike - Short Sale) - Premium received on Put + Premium paid on call = (103 - 96) - 5.30 + 3.90 = 5.60

Beyond 97.4 market price, we will have a loss as we would have to purchase stock at a higher price for the delivery for the short share.

4) Breakeven price = Cost of strategy = 97.40