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		$8.40
2	60		August 19		3.34

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?

The user of this position is betting on _________ volatility. The holder has ________ liability for substantial price declines and __________ liability for substantial price increases.

Answer 1

Call #	Exercise Price	Expiration Date	Market Price	Move
1	50	Aug-19	8.4	Long One call
2	60	Aug-19	3.34	Short two Calls

Answer A.

Price of ARB Stock at Expiration ($)	Profit on Call #1 Position	Profit on Call #2 Position	Net Profit on Total Position
40	-8.4	6.68	-1.72
45	-8.4	6.68	-1.72
50	-8.4	6.68	-1.72
55	-3.4	6.68	3.28
60	1.6	6.68	8.28
65	6.6	-3.32	3.28
70	11.6	-13.32	-1.72
75	16.6	-23.32	-6.72

B

Price of ARB Stock at Expiration ($)	Profit on Call #1 Position	Profit on Call #2 Position	Net Profit on Total Position
First Break Even Point
51.72	-6.68	6.68	0
Second Break Even Point
68.27	9.87	-9.86	0.01

First Break Even Point= $ 51.72

Second Break Even Point = $68.27

Point of Maximum Profit :$ 60

Price of ARB Stock at Expiration ($)	Profit on Call #1 Position	Profit on Call #2 Position	Net Profit on Total Position
60	1.6	6.68	8.28

C. This strategy can make sense only when the market is range bound in the range of roughly $58 to $ 67.Other wise on the lower side it has limited losses but on the higher side it may have unlimited losses.

The user of this position is betting on limited/restricted volatility. The holder has limited liability for substantial price declines and unlimited liability for substantial price increases.