Draw the Profit/loss diagram for the problems below a) Draw the profit/loss diag

Question

Draw the Profit/loss diagram for the problems below

a) Draw the profit/loss diagram of an investor who buys a call for $2.50, and has a strike price of $70. Calculate the maximum profit, maximum loss, and break even point.

b)Draw the profit/loss diagram of an investor who purchases two put options, where the put has a strike price of $45 and the cost of the put option is $2. Label the maximum loss, break even, and maximum profit.

c)Draw the profit/loss diagram of an investor who purchases a call for $3.20, which has a strike of $42, and purchases a put for $1.80, which has a strike of 40. Label the maximum loss, break even, and maximum profit points.

d)Why would an investor consider this option?

Explanation / Answer

(a) Maximum Profit: Unlimited.

Maximum Loss: $2.50.

Break even Point = 2.50+70 = $72.50.

(b) Maximum Loss = $2 x 2 = $4.00.

Maximum Profit = (45 - 0) x 2 = $90.00

Please note that Option Premium paid is not considered in calculating Maximum Profit.

Break even point = 45 - 2 = $43.00

(c) Maximum Loss: $3.20 or $ 1.80

Maximum Profit: Unlimited or $40.00

(d) Best option is (c) as investor is diversifying his/her risk.

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