Question

Three-month European put options with strike prices of $50, $55, and $60 cost $2, $4, and $7, respectively.

1) How can one create a butterfly spread using these options?

2) Please draw the payoff and profit diagrams of this butterfly strategy.

3) What are the maximum gain and maximum loss of the butterfly spread created using these put options?

4) For which two values of ST does the holder of the butterfly spread break even (with a profit of zero), where ST is the stock price in three months?

5) If you use call options to create a butterfly spread that has the same payoff structure as this one, what would be the upfront cost? Why?

Answer 1

Poice Premium - buy met put. NET PAY06. 710 30 10 sem byy met sent this put put +20 +)6. -22 +12 -14 +8... <? 44 418 +6 S2 56 th 60 Gh 72 I what will INVESTOR DO bo (1 buy one shut optim at $ & - Sell one call option at 60 55$ 12 sell one w option at 55 $ & buying me put at lowest Strike Price their means at 50$. conclutin. buy me put at 60$ Sell two pur at 555 buy me put at 50 $ _NET pormium -7 +8-2 =1-11

Poice Premium - buy met put. NET PAY06. 710 30 10 sem byy met sent this put put +20 +)6. -22 +12 -14 +8... <? 44 418 +6 S2 56 th 60 Gh 72 I what will INVESTOR DO bo (1 buy one shut optim at $ & - Sell one call option at 60 55$ 12 sell one w option at 55 $ & buying me put at lowest Strike Price their means at 50$. conclutin. buy me put at 60$ Sell two pur at 555 buy me put at 50 $ _NET pormium -7 +8-2 =1-11

Net pay off -0.5 0 - 10 20 30 40 80 70 80 Net pay off

Q.3

MAXIMUM GAIN = +3

MAXIMUM LOSS= -1

Q.4

Break even for the butterfly spread:-

• Upper Breakeven Point = Strike Price of Highest Strike Long Put - Net Premium Paid

60-1= 59

• Lower Breakeven Point = Strike Price of Lowest Strike Long Put + Net Premium Paid

50+1 = 51

Due to time constraints I have answered first 4 sub Sub parts of the questions to maintain the quality of the answers.

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