Question

4. What follows are several portfolios; each is denoted by the term Port. Graph the profit curve at t = T for each of them. Determine the strengths and weaknesses of each portfolio. Namely, explain what a reasonable investor must be expecting to adopt each portfolio. In this listing, CE denotes a call with strike price E, -CE represents where a person is short on a call- the Call was sold, Pe is a put, -PE is selling, or going short on a put, and the numbers E indicate the strike price. If no number is given, then assume that the strike price is $100. (a) A "Long Call" is Port = CE. (b) A "Short Call" is Port =-CE. (c) A "Long Put" is Port = PE. (d) A "Short Put" is Port PE (e) A "Long Straddle" is Port PE + CE; namely, buy both a Put and Call with the same strike price. (f) A "Short Straddle" is Port--P-C (g) A "Long Strangle" is Port-PE; +CE2; namely, it is a purchase of a put at strike price E1, which is less than the strike price of a (h) a "Short butterfy" is PortCE +2-CEs where Ei < E2 + CE.) where El < (j) A "Short Condor" is Port =-CE1 +CE2 +CE3-CE4 where call at E (i) A "Long butterfly" is Port CE -2C E2 < E3. (k) A "Long Condor" is Port = CE1-CE2-CE3 + CE4

Answer 1

a. The investor is bullish, so he is taking long position.

b. The investor is bearish, so he is taking short position.

c. The investor is bearish, so he is taking long position.

d.  The investor is bullish, so he is taking short position.

e. The investor goes with long straddle strategy, when he knows that the price sensitive information related to the company is going to be out. Eg: During quarterly results.

f. The investor uses short straddle strategy, when the underlying asset will not move significantly higher or lower.

g. The long strangle strategy is almost same as straddle, the only difference is it ha two different strike prices.

h. This strategy is chosen when the forecast for a stock price move outside the range of the highest and lowest stock price.

i. A long butterfly strategy is chosen when the forecast is for stock price action near the center strike price of spread, because long butterfly spreads profit from time decay.

j. It is a neutral strategy similar to short butterfly, with limited risk and limited profit.

k. The investor is looking for ups or downs in the underlying stock and this strategy is profitable if the underlying stock is outside the outer wings at expiration.