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# HW-1743 Investments Week 10 Work two

This chapter covers options strategies, including the covered call, the protective put, the straddle, the bull spread, the bear spread, and collars.

On pages 691-693 of Investments:

• Prepare written answers to Problems

12. A put and a call have the following terms:

Call: strike price $ 30 term three months price $ 3

Put: strike price $ 30 term three months price $ 4 The price of the stock is currently $ 29. You sell the stock short. Illustrate how to use the call or the put to reduce your risk exposure. a) What is the maximum possible profit on the position?

b) What is the maximum possible loss on the position?

c) What range of stock prices generates a profit?

d) What advantage does this position offer?

13. A straddle occurs when an investor purchases both a call option and a put option. Such a strategy makes sense when the individual expects a major price movement but is uncertain as to the direction. For example, a firm may be a rumored takeover candidate. If the rumor is wrong, the stock’s price could decline and make the put profitable. If the rumor is correct and a takeover bid does occur, the price of the stock may rise and the call becomes profitable. There is also the possibility ( probably small, at best) that the price of the stock could rise and subsequently fall, so the investor earns a profit on both the call and the put. The following problem works through a straddle.

Given the following,

Price of the stock $ 50

Price of a six- month call at $ 50 5

Price of a six- month put at $ 503.50 the individual establishes a straddle ( i. e., buys one of each option).

a) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 60?

b) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 40?

c) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 50?

18. Butterfly spreads combine the bull and bear spreads and involve three options with different strike prices and the same expiration date. If the investor expects the price of the stock to be stable ( the butterfly will “ not flap its wings”), the individual buys the options with the highest and lowest strike prices and sells two options with the strike price in the middle. If the investor expects the price of the stock to fluctuate ( i. e., the butterfly will “ flap its wings”), the process is reversed. The investor sells the outer options and buys two of the calls with the strike price in the middle. For example, suppose a stock is selling for $ 61 and there are three- month call options at $ 57, $ callop-tionsat$57,$ 60, and $ 63. The prices of the options are $ 6, $ 3, and $ 1, respectively.

a) The investor expects the price of the stock to be stable. What would the investor gain or lose at the options’ expiration from constructing an appropriate butterfly spread at the following prices of the stock: $ 50, $ 55, $ 57, $ 60, $ 63, $ 65, and $ 70?

b) What is the maximum possible loss?

c) What is the maximum possible gain?

d) What is the range of stock prices that produces a gain from constructing this butterfly?

e) Did the butterfly achieve its objective based on the expectation that the price of the stock would be stable?

References:

Book: Mayo, H.B. (2014). Investments: An introduction (11th Ed.). Mason, OH: South-Western Cengage Learning

Answer will be sent on email.

On pages 691-693 of Investments:

• Prepare written answers to Problems

12. A put and a call have the following terms:

Call: strike price $ 30 term three months price $ 3

Put: strike price $ 30 term three months price $ 4 The price of the stock is currently $ 29. You sell the stock short. Illustrate how to use the call or the put to reduce your risk exposure. a) What is the maximum possible profit on the position?

b) What is the maximum possible loss on the position?

c) What range of stock prices generates a profit?

d) What advantage does this position offer?

13. A straddle occurs when an investor purchases both a call option and a put option. Such a strategy makes sense when the individual expects a major price movement but is uncertain as to the direction. For example, a firm may be a rumored takeover candidate. If the rumor is wrong, the stock’s price could decline and make the put profitable. If the rumor is correct and a takeover bid does occur, the price of the stock may rise and the call becomes profitable. There is also the possibility ( probably small, at best) that the price of the stock could rise and subsequently fall, so the investor earns a profit on both the call and the put. The following problem works through a straddle.

Given the following,

Price of the stock $ 50

Price of a six- month call at $ 50 5

Price of a six- month put at $ 503.50 the individual establishes a straddle ( i. e., buys one of each option).

a) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 60?

b) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 40?

c) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 50?

18. Butterfly spreads combine the bull and bear spreads and involve three options with different strike prices and the same expiration date. If the investor expects the price of the stock to be stable ( the butterfly will “ not flap its wings”), the individual buys the options with the highest and lowest strike prices and sells two options with the strike price in the middle. If the investor expects the price of the stock to fluctuate ( i. e., the butterfly will “ flap its wings”), the process is reversed. The investor sells the outer options and buys two of the calls with the strike price in the middle. For example, suppose a stock is selling for $ 61 and there are three- month call options at $ 57, $ callop-tionsat$57,$ 60, and $ 63. The prices of the options are $ 6, $ 3, and $ 1, respectively.

a) The investor expects the price of the stock to be stable. What would the investor gain or lose at the options’ expiration from constructing an appropriate butterfly spread at the following prices of the stock: $ 50, $ 55, $ 57, $ 60, $ 63, $ 65, and $ 70?

b) What is the maximum possible loss?

c) What is the maximum possible gain?

d) What is the range of stock prices that produces a gain from constructing this butterfly?

e) Did the butterfly achieve its objective based on the expectation that the price of the stock would be stable?

References:

Book: Mayo, H.B. (2014). Investments: An introduction (11th Ed.). Mason, OH: South-Western Cengage Learning

Answer will be sent on email.