Melissa Simmons is the chief investment officer of a hedge fund specializing in options trading. She is currently back-testing various option trading strategies that will allow her to profit from large fluctuations-either up or down-in a stock's price. An example of such typical trading strategy is straddle strategy that involves the combination of a long call and a long put with an identical strike price and time to maturity. She is considering the following pricing information on securities associated with Friendwork, a new Internet start-up hosting a leading online social network:
Friendwork stock: $100
Call option with an exercise price of $100 expiring in one year: $9
Put option with an exercise price of $100 expiring in one year: $8
a. Use the above information on Friendwork and draw a diagram showing the net profit/ loss position at maturity for the straddle strategy. Clearly label on the graph the breakeven points of the position.
b. Melissa's colleague proposes another lower-cost option strategy that would profit from a large fluctuation in Friendwork's stock price:
Long call option with an exercise price of $110 expiring in one year: $6 Long put option with an exercise price of $90 expiring in one year: $5 Similar to Part a, draw a diagram showing the net profit/loss position for the above alternative option strategy. Clearly label on the graph the breakeven points of the position.