The common stock of the P.U.T.T. Corporation has been trading in a narrow price
ID: 2723214 • Letter: T
Question
The common stock of the P.U.T.T. Corporation has been trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next 3 months. You do not know whether it will go up or down, however. The current price of the stock is $80 per share, and the price of a 3-month call option at an exercise price of $80 is $5.00. If the risk-free interest rate is 6% per year, what must be the price of a 3-month put option on P.U.T.T. stock at an exercise price of $80? (The stock pays no dividends.) (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.) What would be a simple options strategy to exploit your conviction about the stock price's future movements? How far would it have to move in either direction for you to make a profit on your initial investment? (Round your intermediate calculations and final answer to 2 decimal places. Omit the "$" sign in your response.)Explanation / Answer
Answer a
For the put call parity we know that
P => C-S + [X/ (1 + r)t ]
=> 5 - 80 + [ 80/ (1+6%)1/4
Put call parity => $ 3.843
Answer b
Cost of a Straddle = > 5 + 3.843
Cost of a Straddle => $8.843