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Option Strategies

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1. Suppose you buy 100 shares of ABC at $70. Create a covered call position using an option contract with a strike price of $80 currently selling at $3.00. Make a spreadsheet and draw a profit/loss diagram and label all significant points for this strategy. What is the payoff to this position if it is closed out at expiration when the stock is selling for $85?

2. XYZ Inc.'s JUN 300 calls ($3 1/4 each), JUN 305 calls ($1 1/2), and JUN 310 calls ($ 1/2) are all available to you. Construct a butterfly spread and show (a) the maximum possible gain and (b) the maximum possible loss and the break-even point. What is the gain or loss if, at expiration, the underlying security sells for exactly $303?

3. Suppose you buy 100 shares of ABC at $79.25 and simultaneously write a March 80 Straddle at the prices given below. Make a spreadsheet and draw a profit/loss diagram and label all significant points for this strategy.

March 80 call at $1.625
March 80 put at $3.50

4. Explain why writing covered calls and writing puts are generally equivalent strategies. Demonstrate with an example.

5. Using the following prices, answer the questions listed below.

CALLS PUTS

EP FEB MAY AUG FEB MAY AUG
JJ 25 3 4 1/4 5 1/2 2 2 1/2 3 3/4
27 1/2 30 1 1 7/8 2 1/2 3 1/8 3 3/4 4 5/8
27 1/2 35 1/8 3/4 1 1/4 7 1/2 8 8

Construct a call bull spread using the May contracts. Show the maximum profit/loss under both strategies. What is the return on investment if the stock is selling at expiration for $33.25? (Ignore transaction costs.)

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Answers a problem set on Option Strategies.

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Option strategies: straddle, butterfly spread, CONDOR, writing covered calls, writing puts, vertical bull spread

1. Suppose you buy 100 shares of ABC at $79.25 and simultaneously write a March 80 Straddle at the prices given below. Make a spreadsheet and draw a profit/loss diagram and label all significant points for this strategy.

March 80 call at $1.625
March 80 put at $3.50

2. XYZ Inc.'s JUN 300 calls ($4 1/4 each), JUN 305 calls ($2 1/2), and JUN 310 calls ($1) are all available to you. You are required to construct a butterfly spread and show (a) the maximum possible gain and (b) the maximum possible loss and the break-even point. What is the gain or loss if, at expiration, the underlying security sells for exactly $302?

3. Look at the situation in question 2 again. Now assume that you also have a JUN 315 call ($0.50) available to you. If you short a CONDOR using the calls-only strategy, what is (a) the maximum possible gain and (b) the maximum possible loss and the break-even point. What is the gain or loss if, at expiration, the underlying security sells for exactly $302?

4. Explain why writing covered calls and writing puts are generally equivalent strategies. Show with an example.

5. Using the following prices, answer the questions listed below.

CALLS PUTS

EP FEB MAY AUG FEB MAY AUG
JJ 25 3 4 1/4 5 1/2 2 2 1/2 3 3/4
27 1/2 30 1 1 7/8 2 1/2 3 1/8 3 3/4 4 5/8
27 1/2 35 1/8 3/4 1 1/4 7 1/2 8 8

a. Using MAY 30/35 construct a vertical bull spread using calls and puts.
b. Show the maximum profit/loss under both strategies.
c. Suppose at expiration the JJ stock sells for $33 1/4. What is the percentage return on your investment? Ignore transaction costs.

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