You wish to enter a Strip Posi
You wish to enter a Strip Position. This will require twoindividual option positions. The following options are to beused.
Call Option 1:Strike = $45, OptionPrice = $4.80
Put Option 2:Strike = $45, OptionPrice = $3.30
Which options are purchased and whichare sold?
How many contracts purchased or soldfor each position?
What are the two break even pointsfor this position?
What is the maximum loss that can beexperienced from entering this position?At what underlying assetprice does this maximum loss occur?
Answer:
(a) Call Option 1: Strike Price = $ 45, OptionPremium = $ 4.8, Put Option 1: Strike Price = $ 45, Option Premium= $ 3.3
In a strip strategy, the first individual position would involvepurchasing two put options and the second individual position wouldinvolve purchasing one call option. Initial Cash Outflow = 2 x 3.3+ 4.8 = $ 11.4
(b) Two put options are purchased as part ofthe first position and one call option is purchased as part of thesecond option.
(c)
| Spot Price | First Put Option | Second Put Option | Call Option | Initial Cash Outflow | Net Cash Flow |
| S < 45 | (45-S) | (45-S) | 0 | 11.4 | (78.6 -2S) $ |
| S > 45 | 0 | 0 | (S-45) | 11.4 | (S-56.4) $ |
Breakeven points would be the asset values at which the net cashflows are zero.
Therefore, breakeven point 1: 78.6 – 2S =0 , S1 = $ 39.3
breakeven point 2: S2 = $ 56.4
(d) The payoff at prices below $ 45 is given bythe equation (78.6 – 2S) and above $ 45 is given by the equation(S-56.4). As is observable the first equation is downward slopingand the second is upward sloping with the switch happening at S = $45
Therefore, the maximum loss is faced at an underlying assetprice of $ 45
Maximum Loss = 78.6 – 2 x 45 = – $ 11.4
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