Question

Assume you want to try make some additional money over the next three months to cushion the blow of no year-end bonus will be pay by your employer.
Call options on a stock TKM are available with strike prices of $13, $15, $17.5, $18.5 and $20 and expiration dates in three months. Their prices are $5.5, $4, $2, $1.5 and $0.5 respectively. Put options on the same stock are available with strike prices of $24, $23.5, $22.5, $21 and $19 and expiration dates in three months. Their prices are $5, $4, $2, $1.5 and $0.5 respectively. TKM is currently trading at $19.40 and assuming the company is in the education industry with a turnover of $120 million per annum and 80 full time employees and the company is in the market for thirty years focusing on higher learning education and adult/executive learning programs. TKM has three main offices in the U.S. and is thinking to explore international business in the future to grow its portfolio.
a) Construct a table showing how profit varies with TKM stock price for your proposed ONE (1) best option strategy to maximize your potential return but yet minimize any potential risks. You may consider various option trading strategies like long straddle, short strangle, protective collar, long butterfly, inverse butterfly etc.
b) Draw your payoff diagram with appropriate labelling from a).
c) Elaborate your payoff diagram with potential return and potential risks.
d) Justify your investment strategy with your own market outlook for the next three months.

Answer 1

OPTION STRATEGY:

1.Buy CALL strike $13

Intrinsic Value =(19.4-13)=$6.4

Cost=$5.5

2.Sell Call at strike =$18.5

Premium Received=$1.5

3.Buy PUT strike $22.5

Intrinsic Value =(22.5-19.4)=$3.1

Cost=$2

4.Sell PUT at strike =$19

Premium Received=$0.5

Net Premium Payment =5.5-1.5+2-0.5=$5.5

Payoff for BUY Call Strike=$13

Price at expiration =S

Payoff=Max.((S-13),0)

Payoff for SELL Call Strike=$18.5

Price at expiration =S

Payoff=Min..((18.5-S),0)

Payoff for BUY PUT Strike=$22.5

Price at expiration =S

Payoff=Max.((22.5-S),0)

Payoff for SELL PUT Strike=$19

Price at expiration =S

Payoff=Min.((S-19),0)

Maximum Payoff=$9.00

Minimum Payoff =$3.50

Maximum Loss=$2.00

Maximum Profit=$3.50

If the stock does not move much, there will be profit