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Consider Stocks A, B, and C. Stock A is currently selling at $13.43. Stock B is...

Consider Stocks A, B, and C. Stock A is currently selling at $13.43. Stock B is currently selling at $25.28. Stock C is currently selling at $10.31. You make the following trades at time 0 (today). a. You sell 3 contracts of puts on Stock A at exercise price of $13.99 and premium of $.91.

b. You implement a 1 contract long straddle on Stock B at exercise price of $25.25. The call premium is $1.21 and the put premium is $1.17.

c. You buy 2 contracts of calls on Stock C at exercise of $8.81. The premium is $3.11.

At time T, the prices are as follows: Stock A = $12.55, Stock B = $26.44, and Stock C = $7.11.

Ignoring any transaction costs, what is your total profit (or loss) on these investments if you unwind all three at time T?

Solutions

Expert Solution

Answer- a:

Number of Contracts = 3

Strike Price of Put Option Sold= 13.99

Premium = 0.91

At time T price of the stock A is 12.55 which is lower than the strike price. It means option buyer will exercise his option and you have obligation to buy the security at strike price.

So loss will be = (Strike Price – Actual Price – Premium Received)

                         = (13.99 – 12.55 – 0.91) = 0.53 per contract

On 3 contracts = 0.53 * 3 = $ 1.59

Answer- b:

Strike Price = 25.25

Call Premium = 1.21 and Put Premium = 1.17

Break Even Point (upper) = 25.25 + 1.21 + 1.17 = 27.63

Break Even Point (lower) = 25.25 – 1.21 – 1.17 = 22.87

At time T price of stock B is 26.44 which is greater than the strike price. It means you will exercise the call option and payoff from call option will offset cost of straddle.

   As the price is below the upper break even you will incur loss from this straddle

   Loss = Actual Price – Strike Price – Premium of options

            = 26.44 – 25.25 – (1.21 + 1.17)

            = 1.19

Answer- c:

Number of contracts = 2

Strike Price = 8.81

Call Premium = 3.11

At time T actual price of stock C is 7.11 which is lower than strike price. It means you will not exercise the call option. Total loss will be equal to premium paid = 3.11

Total Loss = 1.59 + 1.19 + 3.11 = $ 5.89

jeff jeffy answered 2 years ago
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