1. Compute net profits and losses per shares ($ amounts) for Lotus stock at expiration (February 19, 1994) for the following strategies for options that have a strike price of $55. For each option strategy, show payoff diagrams.

• Buying Calls
• Writing Calls
• Buying Puts
• Writing Puts

2. With respect to the strategies in (1):

• Which one of the strategies offers the greatest upside return?
• Which one of the strategies offers the least upside returns?
• Which one of the strategies offers the greatest downside potential?
• Which one of the strategies offers the least downside potential?
• Which strategy is the most aggressive?
• Which strategy is the most conservative?

3. Using numerical examples, if you owned AT&T stock, but were concerned about the possibility of bad news, how might you use options to protect yourself against the risk of a price decline? How might you "subsidize" some or all of the cost of protection? Comment on the risks of your chosen "subsidy" strategy?

4. Compare the prices of options on Lotus and AT&T stock. Why are options with identical strike prices and maturity dates written on stocks with identical prices selling for different prices? Do options on one of these two stocks provide investors with superior investment opportunities in comparison to the other?

5. If Put-Call parity was violated in the case of either AT&T or Lotus, identify a strategy that would allow you take advantage of any mispricing. Using numerical examples, state the exact nature of the mispricing (which option and by how much) and then identify your trading strategy to exploit this mispricing.

Answer rating: 100% (QA)

Question 1 Net Profits and Losses for Lotus Stock Options Strategies Buying Calls When buying a call option with a strike price of 55 the net profit per share at expiration on February 19 1994 would b... View the full answer