suppose a financial manager buys call options on 50,000 barrels of oil with an exercise price of 75 usd per barrel. she simultaneously sells a put option on 50,000 barrels of oil with same exercise price of 75 usd per barrel. consider her gains and loss if oil prices are usd 70,72,75,78,and 80. what do u notice about the pay-off profile?
ANSWER:
STOCK PRICE 70 72 75 78 80
Long Call(S-75) 0 0 0 3 5
Short Put-(75-S) 0 0 0 3 5
It would be great if you guys can check if i am correct.
heavenkid
Wrong on the put. When you sell a put, you get its premium and nothing else.
Looks like the short-put payoff profile is wrong. There should be negative payoff for oil price under 75, and zero payoff for oil price at and above 75, assuming you don’t include put premium you received in calculating payoffs.
What I notice is that, ignoring premiums, the pay off is exactly the same as owning the stock.
If the stock ends up below $75, say at $70; she gets it put to her at $75 and loses $5/share, that’s like buying it for $75 and then holding it and watch it go down to $70.
If the stock ends up above $75, say $85; she exercises the call and makes $10/share, that’s like buying it for $75 and then holding it and watch it go up to $85.
Oops, for “stock” substitute “barrel of oil”.
Looks like a synthetic asset, but without the risk-free investment.