Question

The current price of a stock is $40. The price of a one-year European put option on the stock with a strike price of $30 is quoted at $2 and the price of a one-year European call option on the stock with a strike price of $50 is quoted at $3.

1. (2 points) Investor D wants to own the shares but wants to reduce his initial investment cost. So he buys the stock and shorts the call option on 100 shares.
   1. Draw a diagram illustrating how the investor’s profit varies with stock price. What are his max profit and max loss per share?
   2. Compute his dollar profit and return if the share price is $25, $42, or $56 in one year.
2. (2 points) Investor E wants to bet on the possible share price fluctuations in the coming year. He buys the put option and the call option on 100 shares.
   1. Draw a diagram illustrating how the investor’s profit varies with stock price. What are his max profit and max loss per share?
   2. Compute his dollar profit and return if the share price is $25, $42, or $56 in one year.

Answer 1