Question

An investor buys a butterfly spread on COPCO stock by buying one put option with an exercise price of $50 for $1, buying one put option with an exercise price of $60 for $7 and selling two put options with an exercise price of $55 for $3 each. (above relates to the 3 questions below) (Please show workings)

1. If COPCO’s expiration date stock price is $48, the investor’s profit is: (a) $5 (b) -$2 (c) $1 (d) -$7.

2. If COPCO’s expiration date stock price is $54, the investor’s profit is: (a) $6 (b) -$10 (c) -$6 (d) $2.

3. If COPCO’s expiration date stock price is $62, the investor’s profit is: (a) -$2 (b) $5 (c) -$9 (d) $2

Answer 1

A butterfly spread is put in place when we feel like the price of the underlying will not vary a lot, and only between the two long put options, which in this case is $50 to $60.

Since in this case we are dealing with put options, this is a long put butterfly spread as seen in the image below:

Thus maximum profit is gotten at $55 and max loss possible = 1+7-6 = 2$

Question 1:

Stock Price = $48

Breaking down each option:

$50 long put - Profit.

Payoff = $50 - $48 - $1 = $1

$55 short put - Loss

Payoff = ( $48 - $55 + $3 ) * 2 = -8$

$60 long put - Profit

Payoff = $60 - $48 - $7 = $5

Total = -2$

Thus, answer b)-$2

Question 2:

Stock Price = $54

Breaking down each option:

$50 long put - Not executed - Loss

Payoff = -$1

$55 short put - Profit

Payoff = ( $54 - $55 + $3 ) * 2 = 4$

$60 long put - Loss

Payoff = $60 - $54 - $7 = -1$

Total = 2$

Thus, answer d)$2

Question 3:

Stock Price = $62

Breaking down each option:

$50 long put - Not executed - Loss

Payoff = -$1

$55 short put - Not executed - Profit

Payoff = $3 * 2 = 6$

$60 long put - Not executed - Loss

Payoff = -$7

Total = -2$

Thus, answer a)-$2