Question

Q2) The following prices are given for ATTN Corporation.

ATTN Stock = 31	Call	Put
30 May	$2.00	0.50
35 May	0.25	4
40 May	0.05	9

Draw Profit diagrams [Profit vs. Stock price at expiration S(T)] for the following strategies, clearly showing the strike price (K, maximum profit/ loss, and stock price corresponding to zero profit (Breakeven Point), maximum profit/loss, etc.]

a) Create a bullish vertical spread with May 30 and 35 calls

b) Create a straddle by buying May 35 call and buying May 35 put

c) Create a strangle by buying both a May 35 call and a May 40 put

Answer 1

X Axis = Spot price

Y Axis = Profit\loss

a) Bullish Vertical spread = Buy call with lower strike + Sell Call with Higher strike

Break even point= Lower strike price+ Net premium paid (In this case its 30 + 1.75 = 31.75)

b) Straddle = Buy Call + Buy Put (both with same strike prices).

• Maximum loss = Premium paid for the options
• Maximum gain = Unlimited

C) Strangle = Buy Call + Buy Put (but with different strike prices).

• Maximum loss = Limited ( -4.25 in this case)
• Maximum gain = Unlimited

Additional info:

• Straddle & Strangle must be used in volatile markets, i.e. only if the underlying is voltalile then this strategy will result in profit else the investor will lose his premium.
• Bull spreads are used to get profits from moderate gain in the Spot price.The higher strike price is sold and lower strike price is bought regardless of the option type.
• In Bull call spread the investor pays premium upfront and looks for profit later when it expires which is why its also called as debit call spread.

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