Consider the following option portfolio: You write a January 2012 expiration cal
ID: 2456683 • Letter: C
Question
Consider the following option portfolio: You write a January 2012 expiration call option on IBM with exercise price $168, and the price of the call option is $8.93. You also write a January expiration IBM put option with exercise price $163, the price of the put option is $10.85.
Instructions: for parts a, b, and c, enter your answer as a decimal rounded to the nearest cent.
a. What will be the profit/loss on this position if IBM is selling at $162 on the option expiration date? $
b. What will be the profit/loss on this position if IBM is selling at $174 on the option expiration date? $
Explanation / Answer
Answer:
Position of call option:-
As the market price is lower than exercise price, the buyer of the call option will not exercise the call.
The profit on the call option written is the Call permium of $ 8.93
Position of put option:
The exercise price is $ 163 is higher than the current trading price of IBM stock of $162.
Hence the buyer of the put option will exercise the put option. Hence, loss on exercise of put option is $ (163-162) = $ 1
The put premium earned is $ 10.85. Hence, net profit is $ (10.85-1) = $9.85
Thus, the total profit earned is $ 8.93 + 9.85) = $ 18.78
b)
Position of call option:-
As the market price is higher than exercise price, the buyer of the call option will exercise the call.
The net profit on the call option written is ($ 8.93 - ($174-$168)) = $2.93
Position of put option:
The exercise price is $ 163 is lower than the current trading price of IBM stock of $174.
Hence the buyer of the put option will not exercise the put option.
Hence the profit is put premium earned is $ 10.85.
Thus, the total profit earned is ($ 2.93 + $10.85) = $13.78