Question

Use the table below to answer the questions below.

The following prices are for call and put options on a stock priced at $50.25. The March options have 90 days remaining and the June options have 180 days remaining. In your profit answers below, assume that each transaction is scaled by 100, reflecting the size of option contracts.

	Calls		Puts
Strike	March	June	March	June
45	6.85	8.45	1.20	2.15
50	3.90	5.60	3.15	4.20
55	1.95	3.60	6.15	7.00

a) (10 pts) You think the stock price will end up in the $49 to $51 range around mid March. Selecting from the March call options only, which option strategy from Chapter 7 would you recommend to provide a profit from this low-volatility forecast? What would be your option transactions be to set up this spread? What would be your maximum possible profit from this strategy?

2. (10 pts) Different Scenario:   You think the stock price will fall modestly and end up around $$44-$45 by mid-June.   Selecting from the June put options only, what option strategy would you recommend from Chapter 7 and what would your option transactions be to set it up?

-What would be your profit, in dollars, if the stock price turned out to be $44 at option expiration?

-What is the breakeven terminal stock price for this strategy?

Answer 1

a) In the case of you are expecting a low volatility in the stock from what is actually captured in the option pricing, you can opt for shorting a straddle with strike prices of call and put at 50. Shorting a straddle means you would be selling an call option as well as a put option at the same strike price. In this case, if you sell a call and a put at a strike price of 50, the maximum profit can be realized in case the stock price at expiration is at 50. you would be receiving a premium of 3.90+3.15 = $7.05 per share. Since the size of the option contracts is 100, you would realize a maximum of $705 in this case.

b) In case we are expecting the stock price to fall to 44-45 range, then it is best to buy Put options. From the three put options available, it is best to choose the one with the exercise price of 55, because even though you would be paying a higher premium, you would be able to realize higher profits since the breakeven point is higher in this case.

Strike price	Put price	Break even price
55	7	48
50	4.2	45.8
45	2.15	42.85

Hence, it is better to buy the put option with Strike price of 55. In case the stock price would end up to become $44 during expiry, you would get a profit of ($48-$44)*100 = $400.

As shown in the table, the break even point for this strategy would be $48.