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In-Class Exercise On Option Strategies (Chapter 3) : 1. Long Call and A. Long Put With The Same Strike Price (Straddle)

This document provides an in-class exercise on option strategies and the answers. It includes: 1) Drawings of the profit diagrams for various combinations of long and short calls and puts with different strike prices, such as a straddle, bull spread, and bear spread. 2) Two true/false statements about the relative pricing of at-the-money calls and puts and how the profit diagrams are the same for different combinations of long calls and puts.

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Hins Lee
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112 views4 pages

In-Class Exercise On Option Strategies (Chapter 3) : 1. Long Call and A. Long Put With The Same Strike Price (Straddle)

This document provides an in-class exercise on option strategies and the answers. It includes: 1) Drawings of the profit diagrams for various combinations of long and short calls and puts with different strike prices, such as a straddle, bull spread, and bear spread. 2) Two true/false statements about the relative pricing of at-the-money calls and puts and how the profit diagrams are the same for different combinations of long calls and puts.

Uploaded by

Hins Lee
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FINA2322 Derivatives Dr.

Huiyan Qiu

In-Class Exercise on Option Strategies (Chapter 3) Answers


Draw the rough profit diagram for the following position(s):

1. Long call and


a. long put with the same strike price (Straddle)

b. long put with higher strike price

c. long put with lower strike price

d. short put with the same strike price (Synthetic Long Forward)

1
FINA2322 Derivatives Dr. Huiyan Qiu

e. short put with the higher strike price

f. short put with the lower strike price (flat middle can be above or below x-axis)

g. short call with higher strike price (Bull Spread)

h. short call with lower strike price (Bear Spread)

2
FINA2322 Derivatives Dr. Huiyan Qiu

2. Long put and


a. short call with the same strike price (Synthetic Short Forward)

b. short call with higher strike price (Collar, flat middle can be above or below x-axis)

c. short call with lower strike price

d. short put with higher strike price

3
FINA2322 Derivatives Dr. Huiyan Qiu

e. short put with lower strike price

True or false:

 At-the-money call option is more expensive than at-the-money put if forward price is
higher than the stock price.

The statement is true. According to the put-call parity, the difference between call
option and put option is the present value of the difference between forward price and the
strike price (which is the same as the stock price for at-the-money options).

 (Long K1-strike call + long K2-strike put) generates the same profit diagram as (Long K2-
strike call + long K1-strike put) where K1 and K2 are different.

The statement is true. Suppose K1 < K2, the first combined position is as 1(b) and the
second combined position is as 1(c) above. The profit diagram has the same shape with the
same turning point. If the profit diagrams of the two combined positions are not the same,
there exists arbitrage opportunities: long the position with higher profit diagram and short
the other combined position.

Payoff

K1 K2
4

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