2. While FRY stock is trading for $80 a share, Lela buys a 75 strike call, buys
ID: 2733916 • Letter: 2
Question
2. While FRY stock is trading for $80 a share, Lela buys a 75 strike call, buys an 85 strike call, and sells 2 80 strike calls. The net cost of setting up these positions is $1.50. She does not own the stock.
a. What is the name for this combination of options?
b. What does Lela hope happens to the price of FRY stock?
c. Complete the following table to show the profit at different FRY prices.
FRY Price
at Expiration
Purchased
75 Call Payoff
Purchased
85 Call Payoff
Written
80 Call Payoff
(x2)
Net Cost
of Options
Total Profit
$74
$77
$80
$83
$86
6. A U.S. company knows that it will have to make a loan payment of €5 million in six months. The current exchange rate is $1.28 to €1. (Meaning the loan payment is currently equivalent to $6.4 million)
a. What option position could be used to protect the company from having to make a payment of more than $6.4 million? Be as specific as possible.
b. Suppose that the exchange rate in six months turns out to be $1.35 to €1. How does the option position you described in part (a) work in this case? Show specific numerical steps.
FRY Price
at Expiration
Purchased
75 Call Payoff
Purchased
85 Call Payoff
Written
80 Call Payoff
(x2)
Net Cost
of Options
Total Profit
$74
$77
$80
$83
$86
Explanation / Answer
2. a. The name for this combination of options is Butterfly Spread.
b. Lela hopes that the price of FRY stock is range bound and maximum profit is at Strike Price of Short Calls i.e. price will remain at 80.
c.
6. a. The US Company will buy call option to buy Euro at the strike rate of $1.28 to €1.
b. If the exchange rate in six months turns out to be $1.35 to €1, company can buy €5 Million buy paying $6.4 million.
FRY Price Purchased Purchased Written Net Cost Total Profit at Expiration 75 Call Payoff 85 Call Payoff 80 Call Payoff of Options (x2) $74 0 0 0 -1.5 -1.5 $77 2 0 0 -1.5 0.5 $80 5 0 0 -1.5 3.5 $83 8 0 -6 -1.5 0.5Related Questions
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