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Building strategy using American call and put options

Consider the following table of American option prices of ABC Company at some date when the stock was selling at $80.50. All options expire one month later.
Strike price Market price of call Market price of put
80 2.50 2.20
85 0.70 5.30
90 0.15 9.70
You will be happy to sell the stock for $90 and would like to increase your income if this goal is reached. Suggest a strategy that increases your income at the cost of giving up the upside above $90. How much does it cost you?


Solution Preview

The simplest strategy is to sell a call with a strike price of 90. You will receive $0.15. If the stock price goes beyond $90, the call will be exercised and you will end up getting $90+$0.15 i.e. $90.15. If the stock price is below ...

Solution Summary

This post presents a situation and asks to design an investment strategy by using call and put options to maximize the returns to the investor while meeting the investment objectives. The solution is explained in simple words so that it is easier for the students to make sense of the complexities of dealing with the derivative products.