Question

Clark Kent took following position in Gotham Inc. Bought 1 call at $95 and wrote 1 put at $75. Assume premium on call is $5 and premium on put is $5.

1) What situation would give rise no profit no loss situation?

2) What situation would give rise to maximum loss?

3) What is the maximum possible loss?

4) What situation would give rise to maximum profit?

A) ST<=75

B) 75< St< 95

C)St <= 95

D) cannot determine

Can someone please explain how to find all 4 questions? I need the explanation dumbed down.

Answer 1

Hello Sir/ Mam

Given that:

Clark Kent took 1 call @95 and wrote 1 put at $75.

Hence this means that, for buying call at 95, the maturity price:

• Below or equal to 95 : Payoff = 0
• More than 95 : Inflow = Difference

For writing put at 75, the maturity price:

• More or equal to 75 : Payoff = 0
• Less than 75 : Outflow = Difference

Hence, it is clear that, as call premium and put premium is equal,

(1)

No profit noloss situation : Option B : 75< St< 95

(2)

Maximum Loss:

We'll start incurring loss as and when share price gets down $75, and hence theoretically, Maximum Loss = $75 when St = 0

(3)

Maximum Loss = $75

(4)

Maximum Profit:

We'll earn maximum profit as and when share price goes above $95 and profit will increase henceforth. Hence, maximum profit can not be determined as it is limitless.

I hope this solves your doubt.

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