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# The price of a stock is \$40: Diagram and explain the effects of buying call options and put options

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The price of a stock is \$40. The price of a one year European put option on the stock with a strike price of \$30 is quotes as \$7 and the price of a one year European call option on the stock with a strike price of \$50 is quoted as \$5. Suppose that an investor buys 100 shares, shorts 100 call options, and buys 100 put options.

Draw a diagram illustrating the investor`s profit or loss varies with the stock price over the next year. How does the answer change if the investor buys 100 shares, shorts 200 call options, and buys 200 put options.

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#### Solution Preview

Please refer to the attachments.

The price of a stock is \$40. The price of a one year European put option on the stock with a strike price of \$30 is quotes as \$7 and the price of a one year european call option on the stock with a strike price of \$50 is quoted as \$5. Suppose that an investor buys 100 shares, shorts 100 call options, and buys 100 put options. Draw a diagram illustrating the investor's profit or loss varies with the stock price over the next year. How does the answer change if the investor buys 100 shares, shorts 200 call options, and buys 200 put options.
P0 = 40
Xp = 30
Put = 7
Xc = 50
Call = 5

- If the stock price drops below its strike price of put at \$30, the put is in the money and the investor will use the put to hedge the price. He will then sell the 100 shares at ...

#### Solution Summary

The solution provides a detailed explanation of the results including mathematical calculations. The diagrams are represented in Excel to show potential profit and loss.

\$2.19