Consider the following option portfolio: You write a January 2012 expiration cal
ID: 2798155 • 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 $161 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
Stock<163 Profit=-Max(168-S)+8.93+10.85=S-148.22
163<Stock<168=-Max(S-163,0)-Max(168-S)+8.93+10.85=14.78
Stock>168=-Max(S-163,0)+8.93+10.85=-S+163+19.78=-S+182.78
So, at stock price of 161, profit=161-148.22=13.22
at stock price of 172, profit=-172+180.78=8.78
Breakeven: S=182.78 and S=148.22
Betting that stock price will have low volaitlity and will be rangebound