Question

You are working at an investment bank and trader at your bank invents a new option strategy. The strategy involves longing a call option and shorting a put option on the same stock, with the same strike price, and the same maturity date. Describe and graph the payoffs of this strategy

Answer 1

If I am looking for longing a call option and shorting a put option on the same stock with the same strike price and same maturity date, it will mean that I am trying to be bullish on the stock and I am trying to take double exposure on the stock on the upside because when I am longing a call option,I want the stock to go up in order to gain from the upside and when I am trying to short the put option I mean that I am shorting any opportunity of going the stock on the downside,so I do not believe that its stock will be going downside, so I am shorting the put option,and hence it is just equivalent to buying a call option and it will have unlimited exposure on the downside to so it can be say that this is a double exposure on the upside of a stock and it can prove to be lethal at situations when the stock will be moving in the opposite direction and this can provide a lot of loss to the option holder and a lot of gain when favourable moment is done by the stocks.

The graph of this strategy will be that there would be unlimited possibility of profit and limited possibility of loss because when the stock is going to go up it does not have any upside capping and when the stock is going to go down, then one will be losing upon the put option and he will be exposed to loss of the call option value also.

Let's say I have bought a call option of Reliance of 1100 and shorted a put option of Reliance of 1100. Over all the premium which has been net paid by Me is 30.

When the stock will be going up to 1130,I would not be in a position to make profit and I would be not be able to make any exercise of my call option and when the the price of Reliance with falling under 1100, I will be exposed to upside in the price of put option, because I have shorted it, so it can be said that I need an extraordinary upside on this stock to make money and any limited movement will be exposing me to a lot of loss.