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 MXC Put Option price $0.42 $0.58 Exercise price $74 $70

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

b. 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?

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

Answer 1

• writes a call option with exercise price $74 will receive a premium of $ 0.42 (Writing option means selling Option)
• writes a put option with exercise price $70   will receive a premium of  $ 0.58  (Writing option means selling Option)

Ans a)

Pay off Diagram :

• writes a call option with exercise price $74 : When the stock price Expire at below 74 Option holder i.e. the buyer will not exercise the option. Till thatprofit will be 0.42. But when option expire above 74 buyer will exercise the option, As a seller need to pay the gain or loss . Net Gain or loss above 74 for seller will be = 0.42 - (Expiry Price - 74)
• writes a put option with exercise price $70 :   When the stock price Expire at above 70 Option holder i.e. the buyer will not exercise the option.  Till thatprofit will be 0.58 . But when option expire below 70 buyer will exercise the option, As a seller need to pay the gain or loss . Net Gain or loss below 70 for seller will be = 0.58   +  (Expiry Price - 70)
• Total Pay is Sum of Both Pay off

Pay off Chart :

X Axis : Expiry Price

Y Axis : Total Pay / Profit

Ans b)

From the Pay of Chart

• Total Pay / Profit   on this position if MXC is selling at $72 = 1 (Ans)
• Total Pay / Profit on this position if MXC is selling at $77 = -2   (Ans)

Ans c)

two stock prices will Roy break even on his position :

From the  Total Pay / Profit chart when its profit is more than 0 he will break even from this strategy .

There are two scenario/conditions :

• If the Expiry price is Higher than 69 (Ans)

AND

• If the Expiry price is Lower than 75  (Ans)