1.You believe the price of Twitter stock will move a lot over the next 3 months
ID: 2724990 • Letter: 1
Question
1.You believe the price of Twitter stock will move a lot over the next 3 months, from today’s price of $15. However you don’t know if it will go up or it will go down. You are only sure that the price is going to change a lot over the next 3 months with today being May 1, 2016. Set up a strategy to profit from this point of view by using only options contracts. You are given some info below on actual options contracts for Twitter. Hint: You do not need to use every option contract listed below. Also, you can assume the price for buying the option is the same price you would receive for writing the option.
a.What type of options strategy should you use?
b.What is the maximum profit and loss for this position?
c.Draw the profit and loss diagram for this strategy as a function of the stock price at expiration. (10 points).
Expiration
Strike Price
Option Price
Call Option
May 2016
$15
$0.46
Call Option
August 2016
$15
$0.83
Call Option
September 2016
$15
$1.80
Call Option
December 2016
$15
$2.44
Put Option
May 2016
$15
$0.85
Put Option
July 2016
$15
$1.19
Put Option
September 2016
$15
$2.13
Put Option
December 2016
$15
$2.72
Expiration
Strike Price
Option Price
Call Option
May 2016
$15
$0.46
Call Option
August 2016
$15
$0.83
Call Option
September 2016
$15
$1.80
Call Option
December 2016
$15
$2.44
Put Option
May 2016
$15
$0.85
Put Option
July 2016
$15
$1.19
Put Option
September 2016
$15
$2.13
Put Option
December 2016
$15
$2.72
Explanation / Answer
Answer:
Looking at the option pricing it is clear that put option premium is more than the call option premium and hence the short of put option will fetch more profit hence the staretgy would be shorting the put option and purchasing the call option :
We would take the september month example :
Hence short 1 put september month and purchase one put option for december month and purchase 1 call of september and short december
net benefit would be = 2.13 - 2.72 - 1.80+ 2.44 = $.05 at $15 being the strike price
Hence with this strategy no matter what the share price is the profit would always be $.05 per contract with this startegy as there wont be any loss associated to it and this would be the maximum profit. because if the share price increases with our startegy we have purchase one and short one hence it becomes nullify and similarly we have purchase one put option and short one that will also gets nullify because we have done at the same strike price .
3) Hence graphically the line would be staright having the same profit thrughout
Thank you.
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