Consider the following combination strategy: Long in a December $115 call, premium = $8 and long...

Consider the following combination strategy: Long in a December $115 call, premium = $8 and long in a December $115 put, premium = $4.25.

What type of strategy is this and what type of price expectations does it suggest?
Evaluate the payoff at maturity for 100 share contracts if the prices are $100 and $125 per share.
Diagram the payoff profile for the strategy. Label the break-even prices (including premia).

Solutions

Expert Solution

a) Buying a call and buying a put is a long straddle strategy. It is a strategy where we expect the price to be volatile. If the price moves beyond the band on either side, we make profit.

b) Payoffs

Call payoff = (Spot Price - Strike Price ) (Where S>X) or Zero (Where S<X)

Put Payoffs = (Strike Price - Spot Price) (Where S<X) or Zero (Where S>X)

c) Payoff Profile of the strategy

We find the net profit using various strike price

Break-even Price = Strike Price +/- ( Total Premium)

= 115 + 12.25 or 115 - 12.25

= 127.25 or 102.75

jeff jeffy answered 2 years ago

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