Question

In mid-May, there are two outstanding call option contracts available on the stock of ARB Co.:

Call #	Exercise Price		Expiration Date		Market Price
1	$50		August 19		$8.20
2	60		August 19		3.28

A: Assuming that you form a portfolio consisting of one Call #1 held long and two Calls #2 held short, complete the following table showing your intermediate steps. In calculating net profit, be sure to include the net initial cost of the options. Do not round intermediate calculations. Round your answers to the nearest cent. Use a minus sign to enter negative values, if any. If the answer is zero, enter "0".

Price of ARB Stock at Expiration ($)	Profit on Call #1 Position		Profit on Call #2 Position		Net Profit on Total Position
40	$		$		$
45	$		$		$
50	$		$		$
55	$		$		$
60	$		$		$
65	$		$		$
70	$		$		$
75	$		$		$

B: What are the breakeven stock prices? What is the point of maximum profit? Do not round intermediate calculations. Round your answers to the nearest cent.

The first breakeven point: $

The second breakeven point: $

The point of maximum profit: $

C: Under what market conditions will this strategy (which is known as a call ratio spread) generally make sense? Does the holder of this position have limited or unlimited liability?

Answer 1

under the call ratio spread where we have buy one call and sell two call with buy call @ $8.2 with $50 strike and sell call @ $3.28 with $60 Strike.

(A) for this i have attached excel calculated image with intermediate calculation to know the pay off.

Price at expiration 40 45 50 55 60 Profit on call #1 -8.20 -8.20 -8.20 -8.20 -8.20 -8.20 5-8.2 -3.20 10-8.2 1.80 15-8.2 6.80 20-8.2 11.80 25-8.2 16.80 Profit on call #2 3.28*2 6.56 3.28*2 6.56 3.28*2 6.56 3.28*2 6.56 3.28*2 6.56 (3.28-5)*2 -3.44 (3.28-10)*2 -13.44 (3.28-15)*2 -23.44 Net Profit -1.64 -1.64 -1.64 3.36 8.36 3.36 -1.64 -6.64 65 70 15

(B) In the call ratio spread the buy strike price is break even and if price fall there is no loss and the maximum point of the profit is $60 where profit is $8.36.

(c) under range bound market condition this strategy will be more profitable because when price goes up as you can see the loss is increasing and as goes down the profit down but not converted into loss so main point is that this strategy will not work in upward market but in downward it will not converted into losses.

so the holder have unlimited liability in upward side and limited in downward side.