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In: Finance

Construct profit diagrams or profit tables on expiration to show what position in IBM puts, calls...

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.

Solutions

Expert Solution

                       (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.

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