Payoff - Cost And Profit
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1. a) Write down the profit equation for a long call bull spread.
Answer: Equation: Max Profit: Option Premium + Difference in strike price of OTM & ATM call options
Min Profit: Option Premium
Profit: Option Premium + (Ending price - strike price of ATM call)
b) What are the payoff, cost and profit of a long call bull spread with strike prices of $1,125 and 1,240 if the GOOG share price become $1,210.55 on the expiration date?
Answer: Payoff: 1210.55-1125 = 84.45
Cost:120.3 - 54.5 = 65.80
Profit: 84.45 -65.80 = 18.65
c) What are the payoff, cost and profit of a long put bear spread with strike prices of $1,125 and 1,240 if the GOOG share price becomes $1,210.55 on the expiration date?
Answer: Payoff: 1240-1210.55 = 29.45
Cost:95.60 - 42.60 = 53
Profit: 29.45 -53 = (23.55)
d) Calculate the payoff, cost and profit from a long box spread based on (b) and (c). What strategy is better (call bull/put bear/box)? Explain.
Answer: Payoff: 84.45 + 29.45 = 113.90
Cost:65.80 + 53 = 118.80
Profit: 113.90 - 118.80 = (4.90)
Which strategy & why? The strategy of a long call bull spread is better as it gives more profit than the other two strategies
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2. (a) If you feel that Stock price can go up to $1,400 or can go down to $1,000, but you aren't sure about the direction, what strategy would be more appropriate when you choose options with strike price of 1,220. Calculate the payoff and profit of the strategy.
Answer: Strategy: Long Straddle (Buy one put and one call option at same strike price i.e., 1220)
Payoff: If price= 1400, Payoff from call option = 1400-1220 = 180
If price= 1000, Payoff from put option= 1220-1000 = 220
Profit: If price= 1400, Profit= 180 - 65.40 - 84.50 = 30.10
If price= 1000, Profit= 220 -66.80 - 79.40 = 70.10
(b) At what stock price(s) your profit would be zero in the above case.
Answer: Option cost = 149.10.
Hence, if price = 1220 + 149.10 = 1369.10 or price = 1220 - 149.10 = 1070.90, the profits would be zero.
Therefore, prices = 1369.10/1070.90
(c) If you expect stock price is more likely to go up to $1,400, what strategy would better serve you? Calculate payoff and profit of the strategy.
Answer: A protective put strategy (buying stock and buying put) at a strike price of 1000 shall be bought.
Payoff: NIL
Profit: 1400-1185.55-16.5 = 197.95
(d) Calculate the range of stock prices beyond which your profit would be positive if you follow the strategy in (c)?
Answer: Put option price at 1000 = 16.50
Therefore, any stock price above (1185.55+16.50=) 1202.05 shall yield positive profit results.
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