Question

ABC, a non-dividend paying stock Details of European option prices follows on are as Option type Exercise price Option premium Call on Stock ABC $17.50 $20 $5.50 $3.50 Required: Create a call ratio spread by using the above options. A call ratio spread consists of taking a long position in a bull spread and selling another call on the same stock with the strike price of $20. Draw the profit and loss diagram (on the following page) of the call ratio strategy on the option expiration date. In your profit and loss diagram be sure to show i) the break-even (B/E) points; ii) maximum profit and maximum loss and; ii the slopes of the profit and loss patterns. Support your answers with numerical calculations. Ignore any transaction costs to create the portfolio other than the cost of buying/selling the options C

Answer 1

The position has these legs :

1 long call position with strike price $17.50

2 short call positions with strike price $20

The profit/loss on the position = profit/loss on 1 long call + profit/loss on 2 short calls

A B C Stock ProfitiL ProfitL Profit oss on lon 50 oss on price on positio 00 2$ $1.50 $7.00 14.00 150 ($5.50) ($5.50) $14.50 $1.50 $15.00 $7.00 $15.50 $5.501 $7.00 $150 $16.00 $5.50) $7.00 $150 T $16.50 $5.50) $7.00 $1.50 $17.00 $5.50) $7.00 $1.50 10 $18.00 $5.00) $7.00 $2.00 11 $18.50 ($4.50) $7.00 $2.50 12 $19.00 $4.00) $7.00 $3.00 13 $19.50 $3.50) $7.00 $3.50 14. $20.00 $3.00) $7.00 $4.00 15 $20.50 $2.50) $6.00 $3.50 16 $21.00 ($2.00) $5.00 $3.0 18 $22.00 ($1.00) $3.00 $2.00 19 $22.50 $0.50) $2.00 $150 20 $23.00 $0.00 $1.00 $1.00 21 $23 50 $050 $0.00 $0.50 $1.00)$0.00 $2.00) 0501 22 $24 00 $100 23 $24.50 $1.50 24 $25.00 $2.0 ($3.00) $1.00) ($5.00) ($2 001 $26.00 $3.00 27 $26.50 $3.50 $6.00) $2.50) 28 $27.00 $4.00 7.00) $3.00) ($8.00) ( $3.50) 29 $27.50 $4.50 ($9.00) ($4,00) 30 $28.00 $5.00

Profit on position $5.00 4.00 $1.00 Brofiton nosition ($2.00) ($5.00) $14.00 $14.50 $15.00 $15.50 $16.00 $16.50 $17.00 $17.50 $18.00 $18.50 $19.00 $19.50 $20.00 $20.50 $21.00 $21.50 $22.00 $22.50 $23.00 $23.$0 $24.00 $24.$0 $25.00 $25.50 $26.00 $26.50 $27.00 $27.50 $28.00

i]

break even point is where there is no profit or loss. This occurs at $24.00 stock price on expiry

ii]

Maximum profit = $4.00

Maximum loss = unlimited