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Chapter 5: Q4B (page 512)

Turn back to Figure 15.1, which lists the prices of various IBM options. Use the data in the figure to calculate the payoff and the profits for investments in each of the following January 2012 expiration options, assuming that the stock price on the expiration date is $165.

a. Call option, X = 160

b. Put option, X = 160

c. Call option, X = 165

d. Put option, X = 165

e. Call option, X = 170

f. Put option, X = 170

Short Answer

Expert verified

a. $5,- $10.00

b. -$5, - $14.40

c. $0, - $11.70

d. $0, - $10.85

e. -$5, - $13.93

f. $0, - $ 13.00

Step by step solution

01

Calculation of Payoffs and profits for investment ‘a’

Pay off = Stock price – Exercise price

= $165 - $160 = $5.00

Net profit = Pay off – Call Premium

= $5.00 - $15. = $-10.00

02

Calculation of Payoffs and profits for investment ‘b’

Pay off = Exercise price – stock price

= $160 - $165 = - $5.00

Net profit =Pay off – Put Premium

= -$5.00 - $9.40 = $-14.40

03

Calculation of Payoffs and profits for investment ‘c’

Pay off = Stock price – Exercise price

= $165 - $165 = $0.00

Net profit = Pay off – Call Premium

= $0.00 - $11.7 = $-11.70

04

Calculation of Payoffs and profits for investment‘d’

Pay off = Exercise price – Stock price

= $165 - $165 = $0.00

Net profit =Pay off – Put Premium

= $0.00 - $10.85 = $-10.85

05

Calculation of Payoffs and profits for investment ‘e’

Pay off = Stock price – Exercise price

= $165 - $170 = -$5.00

Net profit = Pay off – Call Premium

= -$5.00 - $8.93 = $-13.93

06

Calculation of Payoffs and profits for investment ‘f’

Pay off = Exercise price – Stock price

= $170 - $165 = $0.00

Net profit = Pay off – Put Premium

= $5.00 - $13.00 = $-13.00

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Most popular questions from this chapter

Consider the following options portfolio: You write a January 2012 expiration calloption on IBM with exercise price \(170. You also write a January expiration IBM putoption with exercise price \)165.

a. Graph the payoff of this portfolio at option expiration as a function of IBM’s stockprice at that time.

b. What will be the profit/loss on this position if IBM is selling at \(167 on the optionexpiration date? What if IBM is selling at \)175? Use The Wall Street Journal listingfrom Figure 15.1 to answer this question.

c. At what two stock prices will you just break even on your investment?

d. What kind of “bet” is this investor making; that is, what must this investor believeabout IBM’s stock price in order to justify this position?

Use the following case in answering Problems 10 – 15 :

Mark Washington, CFA, is an analyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market would most likely experience a slight downturn and suggested delta-hedging the BIC portfolio.

As predicted, the U.S. equity markets did indeed experience a downturn of approximately 4% over a 12-month period. However, portfolio performance for BIC was disappointing, lagging its peer group by nearly 10%. Washington has been told to review the options strategy to determine why the hedged portfolio did not perform as expected.

BIC owns 51,750 shares of Smith & Oates. The shares are currently priced at \(69. A call option on Smith & Oates with a strike price of \)70 is selling at $3.50 and has a delta of .69. What is the number of call options necessary to create a delta-neutral hedge?

Donna Donie, CFA, has a client who believes the common stock price of TRT Materials (currently $58 per share) could move substantially in either direction in reaction to an expected court decision involving the company. The client currently owns no TRT shares, but asks Donie for advice about implementing a strangle strategy to capitalize on the possible stock price movement. A strangle is a portfolio of a put and a call with different exercise prices but the same expiration date. Donie gathers the following TRT option price data:

a. Recommend whether Donie should choose a long strangle strategy or a short strangle strategy to achieve the client’s objective.

b. Calculate, at expiration for the appropriate strangle strategy in part ( a ), the:

i. Maximum possible loss per share.

ii. Maximum possible gain per share.

iii. Break-even stock price(s).

A call option on Jupiter Motors stock with an exercise price of \(75 and one-year expiration is selling at \)3. A put option on Jupiter stock with an exercise price of \(75 and one-year expiration is selling at \)2.50. If the risk-free rate is 8% and Jupiter pays no dividends, what should the stock price be?

Suppose you are attempting to value a one-year maturity option on a stock with volatility (i.e., annualized standard deviation) ofσ= .40. What would be the appropriate values for u and d if your binomial model is set up using the following?

a. 1 period of one year

b. 4 sub-periods, each 3 months

c. 12 sub-periods, each 1 month
See all solutions

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