Consider the following option portfolio: You write a January 2012 expiration cal
ID: 2718716 • 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 $157 on the option expiration date? $
b. What will be the profit/loss on this position if IBM is selling at $172 on the option expiration date? $
c. At what two stock prices will you just break even on your investment (i.e., zero net profit)?
For the put, this requires that: $
For the call this requires that: $
d. What kind of “bet” is this investor making; that is, what must this investor believe about IBM’s stock price in order to justify the position?
betting that the IBM stock price will go up. betting that the IBM stock price will go down. betting that the IBM stock price will have low volatility. betting that the IBM stock price will have high volatility.Explanation / Answer
a. What will be the profit/loss on this position if IBM is selling at $157 on the option expiration date? $
Net cash inflow at beginning = price of the call option + price of the put option
Net cash inflow at beginning = 8.93 + 10.85
Net cash inflow at beginning = 19.78
Payoff at the end i.e cash outflow = payoff of Call option + payoff of put option
Payoff at the end i.e cash outflow = max{(Stock price -strike Price),0} + max{(Strike price - stock price),0}
Payoff at the end i.e cash outflow = max{(157-168),0} + max{(163-157),0}
Payoff at the end i.e cash outflow = 0 + 6
Payoff at the end i.e cash outflow = $ 6
Profit/loss on this position if IBM is selling at $157 = Net cash inflow at beginning - Payoff at the end i.e cash outflow
Profit/loss on this position if IBM is selling at $157 = 19.78-6
Profit/loss on this position if IBM is selling at $157 = 13.78
b. What will be the profit/loss on this position if IBM is selling at $172 on the option expiration date? $
Net cash inflow at beginning = price of the call option + price of the put option
Net cash inflow at beginning = 8.93 + 10.85
Net cash inflow at beginning = 19.78
Payoff at the end i.e cash outflow = payoff of Call option + payoff of put option
Payoff at the end i.e cash outflow = max{(Stock price -strike Price),0} + max{(Strike price - stock price),0}
Payoff at the end i.e cash outflow = max{(172-168),0} + max{(163-172),0}
Payoff at the end i.e cash outflow = 4 + 0
Payoff at the end i.e cash outflow = $ 4
Profit/loss on this position if IBM is selling at $157 = Net cash inflow at beginning - Payoff at the end i.e cash outflow
Profit/loss on this position if IBM is selling at $157 = 19.78-4
Profit/loss on this position if IBM is selling at $157 = 15.78
c. At what two stock prices will you just break even on your investment (i.e., zero net profit)?
For the put, this requires that:
Net cash inflow at beginning = price of the call option + price of the put option
Net cash inflow at beginning = 8.93 + 10.85
Net cash inflow at beginning = 19.78
Net profit = 0
Cash Outflow = Cash Inflow
Cash Outflow required = 19.78
Cash outflow of Call option = 0
Cash outflow of Put option = 19.78
max{(Strike price - stock price),0} = 19.78
max{(163 - stock price),0} =19.78
Stock Price = 163-19.78
Stock Price = $ 143.22
For the call this requires that:
Net cash inflow at beginning = price of the call option + price of the put option
Net cash inflow at beginning = 8.93 + 10.85
Net cash inflow at beginning = 19.78
Net profit = 0
Cash Outflow = Cash Inflow
Cash Outflow required = 19.78
Cash outflow of Put option = 0
Cash outflow of Call option = 19.78
max{(Stock price - Strike price),0} = 19.78
max{(stock price - 168 ),0} =19.78
Stock Price = 168+19.78
Stock Price = $ 187.78
d. What kind of “bet” is this investor making; that is, what must this investor believe about IBM’s stock price in order to justify the position?
betting that the IBM stock price will have low volatility.
Note : Since Investor are selling call option & put option than he is beliving that the movement of stock would be low i.e stock price will have low volatility.