Question

Short a call option with a strike price of $1.25 and a premium of $0.12.

Long a call option with a strike price of $1.35 and a premium of $0.02.

Short a put option with a strike price of 41.35 and a premium of $0.03.

a. Draw the final contigency graph(include break even, max loss, max gain)

b. Compare your final graph with one of the three original graphs(from the question). Tell me if you see an opportunity to make some money. If so, how would you do it?

Answer 1

Payoff = -MAX(Stock Price-1.25,0)+Call strike1.25 prem+MAX(Stock Price-1.35,0)-Call strike1.35 prem-MAX(1.35-Stock Price,0)+Put prem

Max Value = 0.03

Min Value = -1.22 ( will occur when stock price will go to 0)

Breakeven will occur at the stock price of 1.22

To earn an opportunity, he should go long on PUT with strike price=$1.35 and short the portfolio above thus generating the profit