Question

Exercise 4.34. Suppose that you sell for $15 a call option with a strike price of $49, sell for $7 a call option with a strike price of $59, and buy for $10 each two call options with a strike price of $54. Assume a zero rate of interest.

(a) What is the maximum profit possible on the exercise date?

(b) What is the maximum loss possible on the exercise date?

(c) What is the maximum stock price at the exercise date that will result in you breaking even?

Answer 1

Total Cost to enter the trade = 15 + 7 + 2*10 = 42

Refer the payoff Chart of the trade below for each option,

Selling Call Option will bring the risk of unlimited loss when the price goes above Strike at expiry. Where Buying a Call option limits the risk of unlimited loss when the price goes below strike price at expiry.

Price	Sold Strike = 49 : Quantity =01	Sold Strike = 59 Quantity : 01	Bought Strike = 54 Quantity : 02	Total Pay off	Profit
60	-11	-1	12	0	-42
59	-10	0	10	0	-42
58	-9	1	8	0	-42
57	-8	2	6	0	-42
56	-7	3	4	0	-42
55	-6	4	2	0	-42
54	-5	5	0	0	-42
53	-4	6	0	2	-40
52	-3	7	0	4	-38
51	-2	8	0	6	-36
50	-1	9	0	8	-34
49	0	10	0	10	-32
48	1	11	0	12	-30
47	2	12	0	14	-28
46	3	13	0	16	-26
45	4	14	0	18	-24
44	5	15	0	20	-22
43	6	16	0	22	-20
42	7	17	0	24	-18
41	8	18	0	26	-16
40	9	19	0	28	-14
39	10	20	0	30	-12
38	11	21	0	32	-10
37	12	22	0	34	-8
36	13	23	0	36	-6
35*	14	24	0	38	-4

If Price goes below $49 for each decrease in one-dollar price pay off will rise by dollar two.

Ans. (a) Maximum profit.

Assuming price can go to Max zero. The payoff will be, 49*2 108 + 10 = 118

Profit will be 118 - 42 = 76

Ans. (b) : maximum loss possible is $42. (Cost to Enter in Trade)

Ans. (c) To breakeven will happen when the price will fall.

Above $49 price at expiry payoff increases by $2 from $10. To cover the cost of $42 price needs to rise (42- 10)/2 = 16 points.

Breakeven price = 49 - 16 =33