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1) Call options on a stock are available with strike prices of $15, $17
1) Call options on a stock are available with strike prices of $15, $17.5 and $20 and expiration dates in three months. Their prices are $4, $2 and $0.5 respectively. Explain how the options can be used to create a butterfly spread. Construct a table showing how profit varies with stock price for the butterfly spread for four possible price ranges.
2) Suppose that put options on a stock with strike prices $30 and $35 cost $4 and $7, respectively. How can the options be used to create (a) a bull spread and (b) a bear spread? Construct a table that shows the profit and payoff for both spreads for three possible price ranges.
Expert Solution
1)
BUTTERFLY SPREAD:
a. Buy a Call at strike price $15 ---Payment to be made=$4
b. Buy a Call at strike price=$20.....Payment to be made=$0.5
c. Sell TWO calls at strike Price=$17.5..........Payment to be received=2*3=$4
Net Payment =4+0.5-4=$0.5
Assume, Price at expiration =S
Payoff for Buy one Call at Strike $15:
Payoff=Max.((S-15),0)
Payoff for Buy one Call at Strike $20:
Payoff=Max.((S-20),0)
Payoff for SELL TWO Call at Strike $17.5:
Payoff=2*(Min.((17.5-S),0))
| S | A | B | C | D=A+B+C | E=D-0.5 |
| PAYOFF | |||||
| Price at Expiration | Buy One Call@$15 | Buy One Call@$20 | Sell TWO calls @$17.5 | Net Payoff | PROFIT |
| $10 | $0 | $0 | $0 | $0 | ($0.50) |
| $11 | $0 | $0 | $0 | $0 | ($0.50) |
| $12 | $0 | $0 | $0 | $0 | ($0.50) |
| $13 | $0 | $0 | $0 | $0 | ($0.50) |
| $14 | $0 | $0 | $0 | $0 | ($0.50) |
| $15 | $0 | $0 | $0 | $0 | ($0.50) |
| $16 | $1 | $0 | $0 | $1 | $0.50 |
| $17.50 | $3 | $0 | $0 | $3 | $2.00 |
| $18 | $3 | $0 | ($1.0) | $2 | $1.50 |
| $19 | $4 | $0 | ($3.0) | $1 | $0.50 |
| $20 | $5 | $0 | ($5.0) | $0 | ($0.50) |
| $21 | $6 | $1 | ($7.0) | $0 | ($0.50) |
| $22 | $7 | $2 | ($9.0) | $0 | ($0.50) |
| $23 | $8 | $3 | ($11.0) | $0 | ($0.50) |
| $24 | $9 | $4 | ($13.0) | $0 | ($0.50) |
| $25 | $10 | $5 | ($15.0) | $0 | ($0.50) |
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