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    Trading Strategies Involving Options: Practice Questions

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    Hana Lee
    The document contains examples of using options to create various spreads: 1) A butterfly spread can be created using calls with strike prices of $15, $17, and $20. Profit varies depending on the ending stock price relative to the strike prices. 2) A strangle can be created using a $50 call and a $45 put. Profit will result if the stock ends above or below the strike prices. 3) A bull spread uses a $30 put and sells a $35 put. A bear spread uses a $30 put and buys a $35 put. The profit/payoff is outlined for each spread. 4) Put-call parity shows the cost of a butterfly spread

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    Trading Strategies Involving Options: Practice Questions

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    Hana Lee
    675 views3 pages
    The document contains examples of using options to create various spreads: 1) A butterfly spread can be created using calls with strike prices of $15, $17, and $20. Profit varies depending on the ending stock price relative to the strike prices. 2) A strangle can be created using a $50 call and a $45 put. Profit will result if the stock ends above or below the strike prices. 3) A bull spread uses a $30 put and sells a $35 put. A bear spread uses a $30 put and buys a $35 put. The profit/payoff is outlined for each spread. 4) Put-call parity shows the cost of a butterfly spread

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    The document contains examples of using options to create various spreads: 1) A butterfly spread can be created using calls with strike prices of $15, $17, and $20. Profit varies depending on the ending stock price relative to the strike prices. 2) A strangle can be created using a $50 call and a $45 put. Profit will result if the stock ends above or below the strike prices. 3) A bull spread uses a $30 put and sells a $35 put. A bear spread uses a $30 put and buys a $35 put. The profit/payoff is outlined for each spread. 4) Put-call parity shows the cost of a butterfly spread

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    675 views3 pages

    Trading Strategies Involving Options: Practice Questions

    Uploaded by

    Hana Lee
    The document contains examples of using options to create various spreads: 1) A butterfly spread can be created using calls with strike prices of $15, $17, and $20. Profit varies depending on the ending stock price relative to the strike prices. 2) A strangle can be created using a $50 call and a $45 put. Profit will result if the stock ends above or below the strike prices. 3) A bull spread uses a $30 put and sells a $35 put. A bear spread uses a $30 put and buys a $35 put. The profit/payoff is outlined for each spread. 4) Put-call parity shows the cost of a butterfly spread

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    CHAPTER 11 Trading Strategies Involving Options

    Practice Questions
    Problem 11.4. Call options on a stock are available with strike prices of $15, $17 1 , and $20 and 2 1 expiration dates in three months. Their prices are $4, $2, and $ 2 , 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. 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 1 . The initial investment is 2 1 1 . The following table shows the variation of profit with the final stock 4 + 2 2 2 = $ 2 price: Stock Price, ST ST < 15 Profit 1 2

    15 < ST < 17 1 2 17 1 < ST < 20 2 ST > 20

    ( ST 15) 1 2 (20 ST ) 1 2 1 2

    Problem 11.7. A call option with a strike price of $50 costs $2. A put option with a strike price of $45 costs $3. Explain how a strangle can be created from these two options. What is the pattern of profits from the strangle? A strangle is created by buying both options. The pattern of profits is as follows: Stock Price, ST ST < 45 Profit (45 ST ) 5 5

    45 < ST < 50 ST > 50

    ( ST 50) 5

    Problem 11.10. 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. A bull spread is created by buying the $30 put and selling the $35 put. This strategy gives rise to an initial cash inflow of $3. The outcome is as follows:
    Stock Price

    ST 35 30 ST < 35 ST < 30

    Payoff 0

    Profit 3

    ST 35 5

    ST 32 2

    A bear spread is created by selling the $30 put and buying the $35 put. This strategy costs $3 initially. The outcome is as follows:
    Stock Price

    ST 35 30 ST < 35 ST < 30

    Payoff 0

    Profit

    35 ST
    5

    32 ST
    2

    Problem 11.11. Use putcall parity to show that the cost of a butterfly spread created from European puts is identical to the cost of a butterfly spread created from European calls. Define c1 , c2 , and c3 as the prices of calls with strike prices K1 , K 2 and K3 . Define p1 , p2 and p3 as the prices of puts with strike prices K1 , K 2 and K3 . With the usual notation c1 + K1e rT = p1 + S

    c2 + K 2 e rT = p2 + S c3 + K 3e rT = p3 + S
    Hence

    c1 + c3 2c2 + ( K1 + K3 2 K 2 )e rT = p1 + p3 2 p2 Because K 2 K1 = K3 K 2 , it follows that K1 + K3 2 K 2 = 0 and c1 + c3 2c2 = p1 + p3 2 p2 The cost of a butterfly spread created using European calls is therefore exactly the same as the cost of a butterfly spread created using European puts.

    Problem 11.17. What is the result if the strike price of the put is higher than the strike price of the call in a strangle? The result is shown in Figure S11.1. The profit pattern from a long position in a call and a put when the put has a higher strike price than a call is much the same as when the call has a higher strike price than the put. Both the initial investment and the final payoff are much higher in the first case

    Figure S11.1

    Profit Pattern in Problem 11.17

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