Question

You wish to enter a Strip Position. This will require two individual option positions. The following options are to be used.

Call Option 1:Strike = $45, Option Price = $4.80

Put Option 2:Strike = $45, Option Price = $3.30

Which options are purchased and which are sold?

How many contracts purchased or sold for each position?

What are the two break even points for this position?

What is the maximum loss that can be experienced from entering this position?At what underlying asset price does this maximum loss occur?

Answer 1

(a) Call Option 1: Strike Price = $ 45, Option Premium = $ 4.8, Put Option 1: Strike Price = $ 45, Option Premium = $ 3.3

In a strip strategy, the first individual position would involve purchasing two put options and the second individual position would involve purchasing one call option. Initial Cash Outflow = 2 x 3.3 + 4.8 = $ 11.4

(b) Two put options are purchased as part of the first position and one call option is purchased as part of the second option.

(c)

Spot Price	First Put Option	Second Put Option	Call Option	Initial Cash Outflow	Net Cash Flow
S < 45	(45-S)	(45-S)	0	11.4	(78.6 -2S) $
S > 45	0	0	(S-45)	11.4	(S-56.4) $

Breakeven points would be the asset values at which the net cash flows are zero.

Therefore, breakeven point 1: 78.6 - 2S =0 , S1 = $ 39.3

breakeven point 2: S2 = $ 56.4

(d) The payoff at prices below $ 45 is given by the equation (78.6 - 2S) and above $ 45 is given by the equation (S-56.4). As is observable the first equation is downward sloping and the second is upward sloping with the switch happening at S = $ 45

Therefore, the maximum loss is faced at an underlying asset price of $ 45

Maximum Loss = 78.6 - 2 x 45 = - $ 11.4