In: Finance
Construct profit diagrams or profit tables on expiration to show what position in IBM puts, calls and/or underlying stock best expresses the investor’s objectives described below. Assume IBM currently sells for $150 so that profit tables for stock prices between $100 and $200 (in $10 increments) are appropriate. Also assume that "at the money" puts and calls cost $15 each.
? An investor wants upside potential if IBM increases but wants (net) losses no greater than $15 if prices decline.
? An investor wants to capture profits if IBM declines in price but wants a guaranteed limited loss if prices increase.
? An investor wants to profit if IBM’s upcoming earnings announcement is either unexpectedly good or disappointingly bad.
? An investor already owns IBM (at a price of $150) and wants to protect against price declines but wants to retain upside if prices rise. Only one transaction is permitted here.
(1) | (2) | (3) | (4) | (5) |
Current price | Cost of put/call/at the money | Total cost (1+2)) | Stock Prices | Profit/(Loss)(3-4) |
$150 | $15 | $165 | $100 | ($65) |
$150 | $15 | $165 | $110 | ($55) |
$150 | $15 | $165 | $120 | ($45) |
$150 | $15 | $165 | $130 | ($35) |
$150 | $15 | $165 | $140 | ($25) |
$150 | $15 | $165 | $150 | ($15) |
$150 | $15 | $165 | $160 | ($5) |
$150 | $15 | $165 | $170 | $5 |
$150 | $15 | $165 | $180 | $15 |
$150 | $15 | $165 | $190 | $25 |
$150 | $15 | $165 | $200 | $35 |
i) | Range will | |||
Stock price bettwen $150-$200 will suits this investor | ||||
loss cannot accept more than $15 and if IBM prices increased, acceptable. | ||||
Hence max loss will obtain at price of $150 | ||||
ii) | Refer table described as above. | |||
iii) | If price is between $165-$200. investor will get profits by selling this stock during this range, when earnings of company were bad. |