Monday, August 16, 2010

Difficult options question

The so-called "T-chart" is useful when you have to track money-in and money-out on an actual series of transactions, or a series of potential transactions. The following question requires a T-chart and some good, creative problem-solving:

If an investor purchases 100 ABC @44, then writes 1 ABC Aug 45 call @2 and 1 ABC Aug 45 put @2.50, his maximum loss is
A. $450
B. $100
C. $8,450
D. $4,400

EXPLANATION: if the stock goes up and gets called away at $45, that's actually the best that can happen and would be his maximum gain. The worst that can happen is that the stock drops to zero, a loss of $4,400. Then, he'd have to give some clown $4,500 for a worthless stock when the put is exercised. That's $8,900 out, with only $450 coming in for selling the straddle.


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