8. Three month European put options with strike prices of $50, $55, and S60 cost
ID: 2818554 • Letter: 8
Question
8. Three month European put options with strike prices of $50, $55, and S60 cost $2, $4, and $7, respectively. A butterfly spread is created by buying a 50-strike put, selling two 55-strike put, and buying a 60-strike put. The risk-free 3.month interest rate is 5%. (a) What is the maximum gain when a butterfly spread is created from the put options? (b) What is the maximum loss when a butterfly spread is created from the put options? (c) For what two values of Sr does the holder of the butterfly spread breakeven, where ST is the stock price in three months?Explanation / Answer
The butterfly spread is process of neutralization strategy, with 4 Puts option, Investors sell two contracts at the middle strike price, buys 1 contract at a lower strike price, and another contract at a higher strike price.
As per question here,
Sell two middle strike price is $ 55 contract at price of $ 4
Buy the lower strike price is $ 50 contract at price of $ 2
Buy the higher strike price is $ 60 contract at price of $ 7
Answer a)
Maximum Profit = Highest Strike price - Middle strike price + net cost
= $60- $ 55 -$ 1 = $4.
Answer b) Maximum loss(risk) = Amount of cost = $1.
Answer c) There are two breakeven points in the butterfly strategy
Upper breakeven point= Highest strike price - Net cost .= $ 60- $1 = $59 .
lower breakeven point=lowest strike price + Net cost = $50+ $1 = $51..
Cost Sell two middle strike price is $ 55 contract at price of $ 4 $8 Buy the lower strike price is $ 50 contract at price of $ 2 ($2) Buy the higher strike price is $ 60 contract at price of $ 7 ($7) Net cost ($1)Related Questions
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