The market price of ZYX stock has been volatile and you expect that volatility t
ID: 1175106 • Letter: T
Question
The market price of ZYX stock has been volatile and you expect that volatility to continue for a few weeks based on recent news. Due to this belief you decide to purchase calls and puts to manage your exposure. You purchase a one-month call option with a strike price of $25 and an option price of $1.30. You also purchase a one-month put option with a strike price of $25 and an option price of $0.50. What will be your total profit or loss on these option positions if the stock price is $26.0 on the day the options expire?
A. $100
B. -$180
C. -$80
Explanation / Answer
Assuming that each option (both put and call) are for 100 shares each, the net cash outflow on purchasing options would be as given below:
Cash Outflow on Call = 100 x 1.3 = $ 130
Cash Outflow on Put = 100 x 0.5 = $ 50
Total Cash Outflow = $ 180
Cash Profit on Call = (Stock Price - Strike Price) x 100 = (26-25) x 100 = $ 100
Cash Loss on Put = 0 because the put option on account of being out-of-money will not be exercised.
Net Profit = 100
Net Cash Ouftlow (Loss) = 100 + (-180) = - $ 80
Hence, the correct option is (c).
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