Problem # 7 You establish a straddle on Walmart using September call and put opt

Question

Problem # 7 You establish a straddle on Walmart using September call and put options with a strike price of $54. The call premium is $4.45 and the put premium is $5.20. a. What is the most you can lose on this position? b. What will be your profit or loss if Walmart is selling for $62 in September? c. At what stock prices will you break even on the straddle? Problem # 8 We will derive a two-state put option value in this problem. Data: So-250; X-260; 1 +?1.1. The two possibilities for S- are 280 and 180. a. The range of s is 100 while that of P is 80 across the two states. What is the hedge ratio of the put? b-1. Form a portfolio of 4 shares of stock and 5 puts. What is the (nonrandom) payoff to this portfolio b-2. What is the present value of the portfolio?

Explanation / Answer

Ans 7 a) Straddle strategy formed with buying at the money put and call option.

Maximum loss in straddle strategy = net premium paid

= $4.45 + $5.2

= $ 9.65

Ans b) If share is selling for $62 then option holder will be benefitted by call option.

payoff from call will be = $62 - $54 = $8

Since the cost of buying two option is greater than payoff from call option, investor will be in loss

Loss = $ (8 - 9.65) = $1.65

There is loss of $1.65 for option holder

ans c) There is basically two break even point which is given in below formula;

Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid

= $54 + $9.65 = $63.65

Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

= $54 - $9.65 = $43.35

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