Question

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

As per given details, TKM is in education sector with turnover of $120 per annum and good number of strengh is working in company. We assume that company has good potential of growth in next 3 month, so we can develop Long Straddle strategy to maximise profits and minimise risks:

Payoff at various price price at expiry along with graph is as follows:

Particular	Value
Underlying	TKM
Spot Price	19.4
ATM , CE , Buy	20
ATM, PE, Buy	19
CE Premium	0.5
PE Premium	0.5
Net debit	1

Details
Spread		1
Lower Breakeven	18
Upper Breakeven	21
Max Loss		1
Max Loss level		19
Max Profit		Unlimited

Market Expiry	CE_IV	PP	CE Payoff	PE_IV	PP	PE_Payoff	Strategy Payoff
15	0	-0.5	-0.5	4	-0.5	3.5	3
16	0	-0.5	-0.5	3	-0.5	2.5	2
17	0	-0.5	-0.5	2	-0.5	1.5	1
18	0	-0.5	-0.5	1	-0.5	0.5	0
19	0	-0.5	-0.5	0	-0.5	-0.5	-1
20	0	-0.5	-0.5	0	-0.5	-0.5	-1
21	1	-0.5	0.5	0	-0.5	-0.5	0
22	2	-0.5	1.5	0	-0.5	-0.5	1
23	3	-0.5	2.5	0	-0.5	-0.5	2
24	4	-0.5	3.5	0	-0.5	-0.5	3
25	5	-0.5	4.5	0	-0.5	-0.5	4
26	6	-0.5	5.5	0	-0.5	-0.5	5
27	7	-0.5	6.5	0	-0.5	-0.5	6
28	8	-0.5	7.5	0	-0.5	-0.5	7
29	9	-0.5	8.5	0	-0.5	-0.5	8
30	10	-0.5	9.5	0	-0.5	-0.5	9
31	11	-0.5	10.5	0	-0.5	-0.5	10
32	12	-0.5	11.5	0	-0.5	-0.5	11
33	13	-0.5	12.5	0	-0.5	-0.5	12
34	14	-0.5	13.5	0	-0.5	-0.5	13
35	15	-0.5	14.5	0	-0.5	-0.5	14
36	16	-0.5	15.5	0	-0.5	-0.5	15
37	17	-0.5	16.5	0	-0.5	-0.5	16