Question

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

1) What situation would give rise to maximum loss?

2) What is the maximum possible loss? (a. 95 b. 75 c. 85 d. unlimited)

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

4) What situation would give rise maximum profit?

A) ST<=75

B) 75<ST<95

C) ST<=95

D) Cannot determine

can someone please explain how to solve each of the 4 questions? I need the explanation dumbed down. Thank you!

Answer 1

Hello Sir/ Mam

Given that:

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

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

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

For writing call at 75, the maturity price:

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

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

(1)

We start incurring Loss occurs when share price crosses $85 and increases as the share price increases

(2)

Maximum Possible Loss: Unlimited

(3)

No Profit No Loss Situation : $85

As we incur loss as and when price rises above $75 and we earn profit as and when share price falls below $95, we'll find zero profit zero loss situation at the midway, i.e. $85

(4)

Maximum Profit: Share Price @ $0, Maximum Profit = $85

We'll earn maximum profit as and when share price goes below $85 and profit will increase henceforth. Hence, maximum profit we can achieve is at share price at $0

I hope this solves your doubt.

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