Question

A Stock trades for $100. Interest rates for a year are 2%. Calls maturing in a year with exercise prices of $90, $95, $100, $105, and $110 trade at prices of $17, $14, $11, $9, and $7 respectively. Puts maturing in a year with exercise prices of $90, $95, $100, $105, and $110 trade at prices of $4, $6, $8, $11, and $14 respectively. Explain with reasons what option based trading strategies you will use if you expect the end of year price to be between $90 and $95. Write a short answer.

Answer 1

If you expect the end of year price to be between $90 and $95, you can use a bull spread and a bear spread as option-based trading strategies.

Step-by-step explanation:

Based on the given information, if you expect the end of year price to be between $90 and $95, you can use the following option-based trading strategies:

• Buy a call option with an exercise price of $95 and sell a call option with an exercise price of $100. This strategy is called a bull spread. The cost of buying the call option with an exercise price of $95 is $14, and the premium received from selling the call option with an exercise price of $100 is $11. Therefore, the net cost of the strategy is $14 - $11 = $3.
• Buy a put option with an exercise price of $95 and sell a put option with an exercise price of $90. This strategy is called a bear spread. The cost of buying the put option with an exercise price of $95 is $6, and the premium received from selling the put option with an exercise price of $90 is $4. Therefore, the net cost of the strategy is $6 - $4 = $2.