(A) Call option: A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset. Pay off from a call option: The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price. When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff. Profit from a call option: The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier. Put option: A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset. Pay off from a put option: The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price. When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff. Profit from a put option: The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier. A long straddle: It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price. To compute: The most one can lose on the given position.

Question

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Answer 1

Question

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

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Answer 2

Question

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

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Answer 3

Question

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

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Answer 4

Question

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

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Answer 5

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

Answer 6

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Answer 7

Chapter 15, Problem 7PS

Summary Introduction

(A)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The most one can lose on the given position.

Answer 8

Expert Solution

Answer to Problem 7PS

The most one can lose on the given position is $15.5.

Answer 9

Expert Solution

Answer 10

Expert Solution

Answer 11

Expert Solution

Answer 12

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

The situation where the most one can lose on the given position is one with stock price equals to strike price. In this case, there will be no payoff from call option as well as put option. Then the maximum loss will be the sum of premium of call option and the premium of the put option.

Given:

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=$0+$0 at S=X=0Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+0−$7=−$15.5

Answer 13

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Answer 14

Summary Introduction

(B)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The profit or loss from the given straddle if stock price is $88

Answer 15

Expert Solution

Answer to Problem 7PS

The loss from the given straddle if stock price is $88, is $7.50.

Answer 16

Expert Solution

Answer 17

Expert Solution

Answer 18

Expert Solution

Answer 19

Explanation of Solution

In case of a long straddle, the payoff to a straddle is the sum of the payoff of call option and the payoff of put option. Similarly the profit for the portfolio is the sum of the profit/loss of call option and the profit/ loss of put option.

Given:

Stock price (S) = $88

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=$88−$80+0 Payoff from put is 0 if S>X=$8Profit from portfolio=Payoff from put−Put premium+Payoff from call−call premium=0−$8.5+$8−$7=−$7.5

Answer 20

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

Answer 21

Summary Introduction

(c)

Call option:

A call option is an agreement that gives the buyer the right to buy a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the call option is provided is called the underlying asset.

Pay off from a call option:

The payoff from a call contract for its holder is the current price of the underlying asset less the strike price. So, lower the strike price compared to the current price of the underlying asset, higher is the value of the call option. In other words, the worth of call options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is more than the strike price. And the worth of a call option dictates the purchase price of a call option. More worthy the call option, higher will be its purchase price.

When the strike price is more than the stock price, the exercise of call option will cause negative cash flow. So, in that case, call option is not exercised and causes zero payoff.

Profit from a call option:

The profit from a call contract for its holder is the payoff from a call option less its purchase price, paid earlier.

Put option:

A put option is an agreement that gives the buyer the right to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the underlying asset.

Pay off from a put option:

The payoff from a put option contract for its holder is the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

A long straddle:

It is a portfolio where both call and put options on a stock with the same strike price and with the same expiration date are bought. It is beneficial and investors practice it when they believe there will be a large deviation in the stock price but they are not certain about the direction of the movement of stock price.

To compute:

The stock price at which one will break even the straddle

Answer 22

Expert Solution

Answer to Problem 7PS

The stock price at which one will break even the straddle is $95.5 if stock price is more than the strike price while the stock price at which one will break even the straddle is $64.5 if stock price is less than the strike price.

Answer 23

Expert Solution

Answer 24

Expert Solution

Answer 25

Expert Solution

Answer 26

Explanation of Solution

The stock price at which one will break even the straddle should be one that causes no profit and no loss from the given portfolio. There can be two break even points. One is for the stock price more than the strike price and another is for the stock price less than the strike price. For each one case, profit from portfolio should be made zero and then solve for the stock price as shown below to get the required stock prices at which one will break even the straddle.

Given:

Stock price = S

Strike price (X) = $80

Call premium (C) = $7

Put premium (P) = $8.50

Calculation:

Case 1: S>X

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=S−$80+0 Payoff from put is 0 if S>XProfit from portfolio=Portfolio payoff−Put premium−call premium0=S−$80−$8.5−$7Solving for S,S=$95.5

Case 2: X>S

Portfolio Payoff=Payoff from call+Payoff from put=S−X+X−S=0 +$80−SPayoff from call is 0 if X>SProfit from portfolio=Portfolio payoff−Put premium−call premium0=$80−S−$8.5−$7Solving for S,S=$64.5

Answer 27

Ch. 15.2 - Plot the rate of return to the call-plus-bills...Ch. 15.2 - Prob. 2EQ Ch. 15 - Prob. 1PS Ch. 15 - Prob. 2PS Ch. 15 - Prob. 3PS Ch. 15 - Prob. 4PS Ch. 15 - Prob. 5PS Ch. 15 - Prob. 6PS Ch. 15 - Prob. 7PS Ch. 15 - The following diagram shows the value of a put...

Answer to Problem 7PS

Explanation of Solution

Answer to Problem 7PS

Explanation of Solution

Answer to Problem 7PS

Explanation of Solution

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