Consider following strategy: Write both a put and a call on Tesla stock with str
ID: 2720426 • Letter: C
Question
Consider following strategy: Write both a put and a call on Tesla stock with strike prices of $35. The price of the call and put are $3 and $5 respectively.
(a) Draw the payoff diagram for this strategy.
(b) Draw the profit diagram for this strategy.
(c) For what range of prices does this strategy make a profit?
(d) What is the maximum loss to this strategy?
(e) “You employ this strategy if you think volatility will be high.” True or False. Why?
Explanation / Answer
a) Payoff diagram for this strategy.
call potion
Sotck price 25 30 35 40 45 50
Strike price 35 35 35 35 35 35
Status OTM OTM OTM ITM ITM ITM
Action Lapse Lapse Lapse Exercise Exercise Exercise
Gross payoff 0 0 0 5 10 15
Call premium 3 3 3 3 3 3
Net payoff -3 -3 -3 2 7 12
Net payoff -3 -3 -3 2 7 12
Sotck price 25 30 35 40 45 50
b) profit diagram for this strategy.
Put option
payoff diagram for this strategy
Sotck price 25 30 35 40 45 50
Strike price 35 35 35 35 35 35
Status ITM ITM OTM OTM OTM OTM
Action Excecise Excecise Lapse Lapse Lapse Lapse
Gross payoff 10 5 0 0 0 0
Call premium 3 3 3 3 3 3
Net payoff 7 2 -3 -3 -3 -3
Net payoff 7 2 -3 -3 -3 -3
Sotck price 25 30 35 40 45 50
c) Range of prices make a profit.
In case of call option strategy , range of stock price above 40 makes profit .
In case of put option , stock price below makes profit
d) Maximum loss: in case of call option maximum loss is $ 3
in case of put option maximum loss is unlimited.
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