Question

Consider the following option portfolio: You write a January 2012 expiration call option on IBM with exercise price $170, and the price of the call option is $8.93. You also write a January expiration IBM put option with exercise price $165, 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 $164 on the option expiration date? $ b. What will be the profit/loss on this position if IBM is selling at $178 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.

Answer 1

Solution: Profit/(loss) on call option Profit/(loss) on put option=10.85+(164-165) net profit/(loss) 8.93 9.85 18.78 b) Profit/(loss) on call option=8.93+(170-178) Profit/(loss) on put option net profit/(loss) 0.93 10.85 11.78 154.15 For the put=165-10.85 For the call=170+8.93 178.93 betting that the IBM stock price will have low volatility. (low volatility suggests that price would not be moving in any one direction sharply)