Chapter Four
Option Combinations and Spreads
Answers to Problems and Questions
1. A straddle involves a higher maximum profit if the stock remains near the
option striking price. A strangle has a lower maximum profit, but it occurs
over a wider range of prices.
2. A hedge wrapper has three positions (long stock, short call, long put) while a
spread has only two (long one option and short another of the same type).
3. A position that is long 100 shares of stock and short two call contracts has a
profit and loss diagram similar to a short straddle.
4. There is no obvious significant to this point. There will always be such a
common point because the third line is an “average” of the other two. It will
intersect at the average of the two striking prices.
5. The quotation is a cousin of the “don’t put all your eggs in one basket”
proverb.
6. Many speculators follow this practice, but it is not appropriate to say that a
spreader should always do this. Individual circumstances may make some
other alternative preferable.
7. The long call position gives the spreader the ability to acquire the long stock
position needed to cover the short call position.
8. The statement is true. The profit and loss diagram for such a strategy is similar
to a short straddle.
9. If it is not at-the-money, then the striking price is not equal to the stock price.
If the stock price is below the striking price, the put has intrinsic value. If the
stock price is above the striking price, the call has intrinsic value.
10. Writing additional calls brings in additional income and reduces the cost of the
position.
11. The extra long positions give greater upside potential.
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Chapter Four. Option Combinations and Spreads
12. Adding the additional short puts increases the position’s profitability if stock
prices rise sharply.
13. Adding additional long puts means the speculator is more bearish on the
underlying asset.
14. This is possible if the stock price rises before adding the option positions. It is
not necessarily true, however, that a hedge wrapper produces a certain gain.
15. Individual response.
16.
9/16
90
95
94 7/16
4 7/16
17.
1 1/8
91 1/8
95
90
3 7/8
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Chapter Four. Option Combinations and Spreads
18.
1
65
69 70
4
19.
1
71
75
70
4
20.
4
70
85
71
84
75
1
12
80
Chapter Four. Option Combinations and Spreads
21.
66 1/4
78 3/4
3 3/4
65
80
70
75
1¼
22.
3½
76 ½
83 ½
75
80
85
1½
23.
75 call: worth 79 7/16 – 75 = 4 7/16
80 call: worthless
85 call: worthless
Gain or loss:
75 call: 4 7/16 – 7 ¼ = - 2 13/16
80 calls: 2 x (4 – 0) = 8
85 call: 0 - 2 ¼ =
-2¼
Total
2 15/16 gain
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Chapter Four. Option Combinations and Spreads
24. The speculator wants Microsoft to remain below 80 until after option
expiration in August, then advance sharply.
25. This speculator wants the stock to rise above 80 by August expiration (so the
August put expires worthless), then decline sharply so the October put
becomes valuable.
26. Using the prices from Table 4-4, you could write an OCT 95 call and buy an
OCT 70 put. The premium from the call is approximately equal to the cost of
the put. If the stock were to go to zero, the position would show an aggregate
gain (relative to the $60 purchase price) of $10 3/16. The put locks in a
selling price of $70 for a $10 gain, and the premium income exceeded the cost
of the put by 3/16.
27. Buying a 75 put and buying an 80 call,
72 1/8
72 1/8
75
82 7/8
80
2 7/8
28. Buying an 80 put and buying an 85 call,
76 15/16
76 15/16
80
88 1/16
85
3 1/16
This position is similar to the strangle in problem 27. It has a slightly higher
cost and is profitable over a narrower range. Neither strategy is “centered”
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Chapter Four. Option Combinations and Spreads
around the current stock price, however. The problem 27 version will benefit
from a stock rise more readily than a stock decline, and vice versa for the
problem 28 version.
29.
15 15/16
13 7/16
90
95
76 9/16
76 9/16
30.
Stock: 1000 x (84 – 79 7/16) = 4,562.50 gain
90 calls: 500 x (3 3/8 – 0) =
1,687.50 gain
95 calls: 500 x (2 3/8 – 0) =
1,187.50 gain
Total
7,437.50 gain
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