Question

Hello, I don't just need to know the answer but also how to work out the problem by hand. Thanks for any and all help!

24. You buy one Chrysler August 50 call contract and one Chrysler August 50 put contract. The call premium is $4.25 and the put premium is $5.00. Your highest potential loss from this position A) $75 B) $925 C) $5,000 D) unlimited

Answer 1

Position: Long position in call option with strike $ 50 and Long position in put option with strike $ 50, Call Premium = $ 4.25 and Put Premium = $ 5

Let the stock price be $ S

If S < $ 50, then Put Payoff = (50-S) - 5 = (45 - S) and Call Payoff = 0 - 4.25 = - $ 4.25

Net Payoff = (40.75 - S) $

If S > $ 50, then Put Payoff = 0 - 5 = - $ 5 and Call Payoff = (S-50) - 4.25 = (S-54.25) $

Net Payoff = (S - 59.25) $

As is observable the net payoff in both cases is dependent on the stock price at time of maturity. Therefore, the potential loss can be unlimited depending on what the stock price is.

Hence, the correct option is (D)