If an investor executes the following transactions:

-        Owns a security,

-        Sells a call with strike price Kc,

-        Buys a put with strike price Kp, with Kc higher than Kp, and both the call and put have the same expiration date.

a.      Show the payoff matrix, with S being the security price.  Draw a simple diagram to shows the payoffs.

b.      When will these transactions be useful, and the key consideration(s) to implement this strategy ?  What is the benefit of writing the call in this strategy ?

c.      If you owns 100,000 shares of a stock (current stock price : $100) and you are going to execute the above strategy.  You can buy 100,000 puts with an exercise price of $100 for a total premium of $600,000 and sell 100,000 calls with an exercise price of $105 for a total premium of $300,000.  If the stock price finally declines to $90, what is the net value of your portfolio ?

Answer rating: 100% (QA)

Answer Security Price S Strike Price X Call Price Kc Put Price Kp Kc Kp A Payoff Chart B This is a L... View the full answer