Chapter 20, Problem

a.

Summary Introduction

To draw: A payoff and profit diagram to depict a straddle position when the exercise price is $130.

Introduction:

Straddle Strategy: It is one of the strategies used in manipulating the call and put options. In this strategy, the investor faces a position where the call option and the put option are placed in the same position with the same strike price (X) and time (t). In other words, a straddle is supposed to be the combined value of both the call option and the put option.

Answer

We can conclude that an increase in price increased profit also.

Explanation of Solution

The information given to us is as follows:

Statement showing the prices of the options in straddles and spreads
Straddles and Spreads
Stock prices
Market Price	116.5
Market price	130				X110 Straddle		X120 Straddle
					Ending Stock price	Profit	Ending Stock price	Profit
Buying options:						-15.4		-24
Strike	Price	Payoff	Profit	Return%	50	24.6	50	36
110	22.8	20	-2.8	-12.28%	60	14.6	60	26
120	16.8	10	-6.8	-40.48%	70	4.6	70	16
130	13.6	0	-13.6	-100.00%	80	-5.4	80	6
140	10.3	0	-10.3	-100.00%	90	-15.4	90	-4
					100	-25.4	100	-14
Strike	Price	Payoff	Profit	Return%	110	-35.4	110	-24
110	12.6	0	-12.6	-100%	120	-25.4	120	-34
120	17.2	0	-17.2	-100%	130	-15.4	130	-24
130	23.6	0	-23.6	-100%	140	-5.4	140	-14
140	30.5	10	-20.5	-67.21%	150	4.6	150	-4
					160	14.6	160	6
Straddle	Price	Payoff	Profit	Return%	170	24.6	170	16
110	35.4	20	-15.4	-43.50%	180	34.6	180	26
120	34	10	-24	-70.59%	190	44.6	190	36
130	37.2	0	-37.2	-100%	200	54.6	200	46
140	40.8	10	-30.8	-75.49%	210	64.6	210	56
Selling options:
Call options	Price	Payoff	Profit	Return%	Ending	Bullish Spread
					Stock price	7.5
110	22.8	-20	2.8	12.28%	50	-12.5
120	16.8	-10	6.8	40.48%	60	-12.5
130	13.6	0	13.6	100.00%	70	-12.5
140	10.3	0	10.3	100.00%	80	-12.5
					90	-12.5
Put options	Price	Payoff	Profit	Return%	100	-12.5
110	16.6	0	12.6	100.00%	110	-12.5
120	17.2	0	17.2	100.00%	120	-2.5
130	23.6	0	23.6	100.00%	130	7.5
140	30.5	10	40.5	132.79%	140	17.5
					150	17.5
Money spread	Price	Payoff	Profit		160	17.5
Bullish spread					170	17.5
Purchase of Call option at 110	22.8	20	-2.8		180	17.5
Selling of Call option at 140	10.3	0	10.3		190	17.5
Combined profit		20	7.5		200	17.5
					210	17.5

  

Let us use the same diagram for both the answers. Let us now understand the depiction of payoff and profit using a straddle strategy.

Like said before, in straddle strategy, both the call position and put position will be placed at the same place with the same strike price and expiration time. Let us observe the diagram. The blue shows the payoff and profit using a straddle strategy.

This diagram clears shows that when the price option of $110, the payoff is $20 and the net profit earned is $34.60. In a case where the price is $120, the profit earned is $44.60 and when the price rises to $130 the profit earned also rises to $54.60. Therefore, it means an increase in price increased profit also.

b.

Summary Introduction

To draw: A payoff and profit diagram to depict a bullish spread position when the exercise price is $120 and $130 assuming the excel position.

Introduction:

Bullish spread position: It is supposed to be a very optimistic option strategy. It is designed in such a way that profit can be earned even if there is a moderate increase in the price of the underlying asset.

Answer

We can conclude that irrespective of a decline in market conditions, a net profit of $7.50 is earned.

Explanation of Solution

The information given to us is as follows:

Statement showing the prices of the options in straddles and spreads
Straddles and Spreads
Stock prices
Market Price	116.5
Market price	130				X110 Straddle		X120 Straddle
					Ending Stock price	Profit	Ending Stock price	Profit
Buying options:						-15.4		-24
Strike	Price	Payoff	Profit	Return%	50	24.6	50	36
110	22.8	20	-2.8	-12.28%	60	14.6	60	26
120	16.8	10	-6.8	-40.48%	70	4.6	70	16
130	13.6	0	-13.6	-100.00%	80	-5.4	80	6
140	10.3	0	-10.3	-100.00%	90	-15.4	90	-4
					100	-25.4	100	-14
Strike	Price	Payoff	Profit	Return%	110	-35.4	110	-24
110	12.6	0	-12.6	-100%	120	-25.4	120	-34
120	17.2	0	-17.2	-100%	130	-15.4	130	-24
130	23.6	0	-23.6	-100%	140	-5.4	140	-14
140	30.5	10	-20.5	-67.21%	150	4.6	150	-4
					160	14.6	160	6
Straddle	Price	Payoff	Profit	Return%	170	24.6	170	16
110	35.4	20	-15.4	-43.50%	180	34.6	180	26
120	34	10	-24	-70.59%	190	44.6	190	36
130	37.2	0	-37.2	-100%	200	54.6	200	46
140	40.8	10	-30.8	-75.49%	210	64.6	210	56
Selling options:
Call options	Price	Payoff	Profit	Return%	Ending	Bullish Spread
					Stock price	7.5
110	22.8	-20	2.8	12.28%	50	-12.5
120	16.8	-10	6.8	40.48%	60	-12.5
130	13.6	0	13.6	100.00%	70	-12.5
140	10.3	0	10.3	100.00%	80	-12.5
					90	-12.5
Put options	Price	Payoff	Profit	Return%	100	-12.5
110	16.6	0	12.6	100.00%	110	-12.5
120	17.2	0	17.2	100.00%	120	-2.5
130	23.6	0	23.6	100.00%	130	7.5
140	30.5	10	40.5	132.79%	140	17.5
					150	17.5
Money spread	Price	Payoff	Profit		160	17.5
Bullish spread					170	17.5
Purchase of Call option at 110	22.8	20	-2.8		180	17.5
Selling of Call option at 140	10.3	0	10.3		190	17.5
Combined profit		20	7.5		200	17.5
					210	17.5

  

Let us use the same diagram for here also. Let us now understand the depiction of payoff and profit using a bullish spread strategy. The yellow line shown in the diagram depicts payoff and profit using a bullish spread strategy. When the diagram is observed, we find that when a call option is purchased at $110, the market is decreasing. When a call option is sold at $140, the net profit earned is $7.50. So, irrespective of a decline in market conditions, a net profit of $7.50 is earned.