Option Payoffs. Consider the following two butterfly spreads (Spread A and Spread B) with the following...

    

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Option Payoffs. Consider the following two butterfly spreads (Spread A and Spread B) with the following payoffs: payoff 12 10 8 (0 A 2 Spread-A Spread-B 10 20 30 40 50 ST 1 60 70 Both spreads are based on the same underlying stock and payoff at T = 80 90 1 year. 100 (a) (5 points) Find portfolios using calls, puts, stocks, and/or bonds to replicate the payoffs of Spread A and Spread B. Solution: (b) (5 points) On the graph below, draw the payoff when you go long B and short spread A. Do not include the upfront premiums, only the terminal payoffs at T = 2. Solution: If follod 20 15 10 5 0 -5 -10 0 10 20 30 40 50 ST 60 70 80 90 100 :) (5 points) Suppose that the price of spread B is lower than the price of spread A. Explain how you can construct an arbitrage. Solution: Option Payoffs. Consider the following two butterfly spreads (Spread A and Spread B) with the following payoffs: payoff 12 10 8 (0 A 2 Spread-A Spread-B 10 20 30 40 50 ST 1 60 70 Both spreads are based on the same underlying stock and payoff at T = 80 90 1 year. 100 (a) (5 points) Find portfolios using calls, puts, stocks, and/or bonds to replicate the payoffs of Spread A and Spread B. Solution: (b) (5 points) On the graph below, draw the payoff when you go long B and short spread A. Do not include the upfront premiums, only the terminal payoffs at T = 2. Solution: If follod 20 15 10 5 0 -5 -10 0 10 20 30 40 50 ST 60 70 80 90 100 :) (5 points) Suppose that the price of spread B is lower than the price of spread A. Explain how you can construct an arbitrage. Solution:

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a To Replicate the above mentioned strategies we need to take following positions Spread A Buy a Call at Strike Price of 40 Sell 2 Calls at Strike Pri... View the full answer