Question

Consider the following options portfolio: You write a November 2014 expiration call option on Facebook with exercise price $80. The price of this call is $2.64. You also write a November expiration Facebook put option with exercise price $75. The price of this put is $ 3.97.

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

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

c. What kind of “bet” is this investor making; that is, what must this investor believe about the stock price in order to justify this position?

Answer 1

Stock Price	Payoff from call	Payoff from put	TOTOAL PAYOFF
66	0	-9	-9
67	0	-8	-8
68	0	-7	-7
69	0	-6	-6
70	0	-5	-5
71	0	-4	-4
72	0	-3	-3
73	0	-2	-2
74	0	-1	-1
75	0	0	0
76	0	0	0
77	0	0	0
78	0	0	0
79	0	0	0
80	0	0	0
81	-1	0	-1
82	-2	0	-2
83	-3	0	-3
84	-4	0	-4
85	-5	0	-5
86	-6	0	-6
87	-7	0	-7
88	-8	0	-8
89	-9	0	-9
90	-10	0	-10
91	-11	0	-11
92	-12	0	-12
93	-13	0	-13
94	-14	0	-14
95	-15	0	-15

PAYOFF AND PROFIT DIAGRAM

b) When Stock price is 77

Stock Price	Payoff from call	Payoff from put	TOTOAL PAYOFF	PREMIUM RECEIVED	PROFIT
77	0	0	0	6.61	6.61

c) Investor is making a bet that stock price will remain rangebound (ie it wont go up very much neither it will fall very much).

Investor believes the range of the stock will be

Upper Range = Strike of Call + premium recieved

Upper Range = 80 + 6.61 = 86.61

Lower Range = Strike of PUT - premium recieved = 75 - 6.61 = 68.39

If price of facebook is outside the range of 68.39 - 86.61 investor will incurr loss