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Derivatives Securities and Markets

Problem Set: Trading Strategies Involving Options

Question #a

Three put options on a stock have the same expiration date and strike prices of $55, $60, and $65. The market prices are $3, $5, and $8, respectively.

A. Explain how a butterfly spread can be created.

B. Construct a table showing the profit from the strategy.

C. For what range of stock prices would the butterfly spread lead to a loss?

Question #b

 A call with a strike price of $60 costs $6. A put with the same strike price and expiration date costs $4. Construct a table that shows the profit from a straddle.  

A. Explain how a straddle can be created.

B. Construct a table showing the profit from the strategy.

C. For what range of stock prices would the straddle lead to a loss?

Question #c

A trader sells a strangle by selling a European call option with a strike price of $50 for $3 and selling a European put option with a strike price of $40 for $4.    

A. Construct a payoff diagram from the above position.

B. Construct a table showing the profit from the strategy.

C. For what range of prices of the underlying asset at maturity does the trader make a profit?