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In: Finance

Suppose a stock is trading at $4 in July. An options trader executes a spread by...

Suppose a stock is trading at $4 in July. An options trader executes a spread by selling an August put with strike $30 for $50, buying an August put with strike $40 for $300, buying an August call with strike $40 for $300 and selling an August call with strike 50 for $50. Write the payoff function of the spread and provide the corresponding diagram. Write a paragraph discussing if the spread provides a limited/unlimited profit potential and possible corresponding risks.

Solutions

Expert Solution

This is a very strange strategy with a payoff of -490 which is fixed for various prices of the stock. Thus, this strategy is good for limiting losses, but the scope of earning profit is not there if we follow this strategy.

The primary risk is limited though there is a confirmed loss as per the stated strategy. It mitigates any volatility of payoff though.

jeff jeffy answered 1 year ago
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