Mr. Dapang expects the tracking stock on Dow Jones Industrial Average to trade o
ID: 2779632 • Letter: M
Question
Mr. Dapang expects the tracking stock on Dow Jones Industrial Average to trade out of the current range of price a lot, but he is not sure about which direction the will go. Based on his expectation, he believes a profitable trading oppourtunity is to initiate a short butterfly spread strategy using call options on DIA. The premium of the one month calls with strike price of $88, $92, and $96 are $4.2, $2, and $0.5, respectively. Mr. danpang wants a butterfly spread using a total of 2 long contracts and 2 short contracts with each contract for 100 shares. The breakeven prices from the buttery at expiration are ____ and ______.
Explanation / Answer
Call holder at 88$ (Long)
SP AP OPTION BY CALL HOLDER VALUE TO CALL HOLDER PREMIUM PAYOFF
88 86 Lapse 0 4.2 -4.2
88 88 Lapse 0 4.2 -4.2
88 90 Exercise 2 4.2 -2.2
88 92 Exercise 4 4.2 -0.2
88 94 Exercise 6 4.2 2.2
88 96 Exercise 8 4.2 4.2
88 98 Exercise 10 4.2 6.2
88 100 Exercise 12 4.2 8.2
88 102 Exercise 14 4.2 10.2
Call holder at 96$ (Long)
SP AP OPTION BY CALL HOLDER VALUE TO CALL HOLDER PREMIUM PAYOFF
96 86 Lapse 0 2 -2
96 88 Lapse 0 2 -2
96 90 Lapse 0 2 -2
96 92 Lapse 0 2 -2
96 94 Lapse 0 2 -2
96 96 Lapse 0 2 -2
96 98 Exercise 2 2 0
96 100 Exercise 4 2 2
96 102 Exercise 6 2 4
Call Writer at 92$ (Short)
SP AP OPTION BY HOLDER VALUE TO CALL HOLDER PREMIUM PAYOFF
92 86 Lapse 0 0.5 0.5
92 88 Lapse 0 0.5 0.5
92 90 Lapse 0 0.5 0.5
92 92 Lapse 0 0.5 0.5
92 94 Exercise 2 0.5 -1.5
92 96 Exercise 4 0.5 - 3.5
92 98 Exercise 6 0.5 - 5.5
92 100 Exercise 8 0.5 - 7.5
92 102 Exercise 10 0.5 - 9.5
COMPUTATION OF NET PAYOFF
AP PAY OFF AT 88$ + PAY OFF AT 96$ + 2(PAYOFF AT 92$) = NET PAYOFF FOR 100SHARES
86 -4.2 + -2 2(0.5) = -5.2X100 = -520
88 -4.2 + -2 2(0.5) = -5.2X100 = -520
90 -2.2 + -2 2(0.5) = -3.2X100 = -320
92 -0.2 + -2 2(0.5) = -1.2X100 = -120
94 2.2 + -2 2(-1.5) = -2.8X100 = -280
96 4.2 + -2 2(-3.5) = -4.8X100 = -480
98 6.2 + 0 2(-5.5) = -4.8X100 = -480
100 8.2 + 2 2(-7.5) = -4.8X100 = -480
102 10.2 + 4 2(-9.5) = -4.6X100 = -460
Break even for 88 at 90
Break even for 92 at 94
Break even for 96 at 98
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