QUESTION 5 [1 + 2 + 1 = 4 MARKS]

An investor believes that there will be a small change in a stock price but she is unsure of whether it will be a small drop or a small increase. A call with a strike price of $50 costs $6. A put with the same strike price and expiration date costs $4.

a) Given his beliefs, which one of the following strategies makes sense for the investor? Choose one and explain your choice

1. A Short (or, reverse) Calendar spread

2. A Box spread

3. A Short straddle

4. A Bear spread using Calls

b) Construct a table that shows the profit from the strategy you chose in a) above.

c) For what range of stock prices would the strategy you chose in a) lead to a loss?