Lemon Computer is a publicly-traded firm that is currently engaged in a lawsuit
ID: 2769964 • Letter: L
Question
Lemon Computer is a publicly-traded firm that is currently engaged in a lawsuit over its patents. If it wins the lawsuit, the stock price is expected to increase by 30%. If it loses the lawsuit, its stock price is expected to fall by 30%. Which option strategy could you use to make a profit from this situation?
Using the following information calculate the portfolio value on the exercise date and the profit from your strategy.
Stock price today = S0=$100
Strike Price= X = $100
Call Price =$12.34
Put Price = $9.87
Scenario 1: Lemon wins the lawsuit and the stock price increases to $130.
Scenario 2: Lemon loses the lawsuit and the stock price falls to $70.
Explanation / Answer
Scenario 1
If Lemon wins he suit, it should buy the stock and the call option.
Net profit = (Ending price – purchase price) +Max (Ending price – strike price, 0) – premium paid
= (130 -100) + max(130-100,0) -12.34
= 30+30-12.34
= 47.66
Scenario 2
If Lemon loses the lawsuit, it should buy put option and short the call option.
Net profit = max( Strike price – ending price, 0) + min(strike price- ending price , 0) – net premium paid
= max (100 -70 , 0) + min (100-70,0) – (9.87-12.34)
= 30 +0 +2.47
= 32.47
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