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call options on a stock are available with strike prices of $15, $17
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.
Expert Solution
ANSWER
An investor can create a butterfly spread by buying call options with strike prices of $15 and $20 and selling two call options with strike prices of $17.5
The initial investment is 4+0.5-2X2=0.5.
The following table shows the variation of profit with the final stock price:
| STOCK PRICE , St | PROFIT |
| ST<15 | -0.5 |
| 15<ST<17.5 | (ST-15)-0.5 |
| 17.5<ST<20 | (20-ST)-0.5 |
| ST>20 | -0.5 |
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