Question

Roy constructs an options portfolio based on the MXC stock. He writes a call option with exercise price $74 and writes a put option with exercise price $70. Both options have the same expiration date.

  

MXC Call Option price $0.42

Exercise price $74

MXC Put $0.58 $70

       

1. Draw the payoff diagram of this portfolio at option expiration as a function of MXC stock price at that time.

2. What will be the profit/loss on this position if MXC is selling at $72 on the option expiration date? What if MXC is selling at $77?

3. At what two stock prices will Roy break even on his position?

Answer 1

Call option gives it's buyer right to buy the underlying at specified price in future. Thus when market price as at expiry is more than strike price, call option will get exercised

Here we have written call option hence we will receive premium of $0.42

Put option gives it's buyer right to Sell the underlying at specified price in future. Thus when market price as at expiry is less than strike price, put option will get exercised

Here we have written put option hence we will receive premium of $0.58

Statement showing Payoff and net profit/loss on position

Price as at expiry	Loss on call option shorted Strki price = 74$	Loss on Put option shorted Strki price = 70$	Payoff	Premium received (0.42+0.58)	Net profit/loss
63		-7	-7	1	-6
64		-6	-6	1	-5
65		-5	-5	1	-4
66		-4	-4	1	-3
67		-3	-3	1	-2
68		-2	-2	1	-1
69		-1	-1	1	0
70			0	1	1
71			0	1	1
72			0	1	1
73			0	1	1
74			0	1	1
75	-1		-1	1	0
76	-2		-2	1	-1
77	-3		-3	1	-2
78	-4		-4	1	-3
79	-5		-5	1	-4
80	-6		-6	1	-5
81	-7		-7	1	-6

Thus if stock price as at expity is 72$ , total profit loss from the strategy = 1$

if stock price as at expity is 77$ , total profit loss from the strategy = -2$

At 75$ and 69$ this strategy will break even

Diagram