14. The common stock of the C.A.L.L. Corporation has been trading in a narrow ra

Question

14.

The common stock of the C.A.L.L. Corporation has been trading in a narrow range

around $50 per share for months, and you believe it is going to stay in that range for the

next three months. The price of a three-month put option with an exercise price of $50 is

$4, and a call with the same expiration date and exercise price sells for $7.

(LO 15-2)

a.

What would be a simple options strategy using a put and a call to exploit your con

-

viction about the stock price’s future movement?

b.

What is the most money you can make on this position?

c.

How far can the stock price move in either direction before you lose money?

d.

How can you create a position involving a put, a call, and riskless lending that would

have the same payoff structure as the stock at expiration? The stock will pay no divi

-

dends in the next three months.

e.

What is the net cost of establishing that position now?

Explanation / Answer

a. Since stock price has remained at $50 and is expected to remain there. Simple strategy is to sell both call and put option. We will get $4 + $7 = $11 by selling 1 call and 1 put option. Now if the stock price stays in range $50-11 to $50+11 = [$39,$61], we will be profitable. The movement of +-$11 is 22% movement in stock which is very unlikely to happen as we think that stock will remain at $50 levels.

b. Most money is $11, if the stock remains at $50

c. As calculated above if stock falls below $39 OR goes above $61, we loose money

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