Kung Chen expects the tracking stock on the Dow Jones Industrial Average (DIA) to trade within a narrow range around its current price over the near term. Based on his expectation, he believes a profitable trading opportunity is to initiate a butterfly spread strategy using call options on DIA. Osborne suggests using three one-month call options on DIA. Exhibit 3 illustrates current DIA call options expiring in one month. Chen wants a butterfly spread using a total of 200 long contracts and 200 short contracts.
Call options
- Exercice price of 88 with an option premium of 4.20
- Exercice price of 92 with an option premium of 2
- Exercice price of 96 with an option premium of 0.2
If Chen creates a butterfly spread using the three one-month call options suggested by Osborne, the maximum potential loss at expiration is closest to:
A. $3,000. B. $7,000. C. $27,000.
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I get A but according to CFAI, answer is B.
Here’s how I get A.
Need 100 long contracts of the options with a strike or $88 so you spend (100 contracts x 100 shares/contract x $4.2) = -42,000
Need 200 short contracts of the options with a strike of $92 so you get (200 contracts x 100 shares/contract x $2 premium) =+40,000
Need 100 long contracts of the option with a strike of $96 so you spend (100 contracts x 100 shares/contract x $0.50 premium)= -5,000
Maximum loss = -42,000 + 40,000 -5,000 = +3,000
I’m wondering how they get 7,000 ?
Thank you !