A. It is April 20, 2015. Apples (Ticker: AAPL) current stock price is $128. Apple releases earnings April 27, 2015, and the stock price will likely be either higher or lower the following day if Apple beats or misses analyst earnings expectations, respectively. In sharp contrast to your fellow market participants, you believe that the likelihood of AAPL experiencing a dramatic stock market reaction to the earnings news is very high (i.e., you believe that Apples stock price is either going to be much higher than $128 or much lower than $128; in contrast, your fellow market participants believe that Apples stock price will remain rather stable around $128). You can either buy (hold) or sell (write) one European call option on AAPL with strike price = $128 and expiration date = May 1, 2015. Also, you can either buy (hold) or sell (write) one European put option on AAPL with strike price = $128 and expiration date = May 1, 2015.

You firmly believe that youre right and that the market is wrong. What strategy would you choose? (circle the right answer)

i) You would buy (hold) the call option and buy (hold) the put option.

ii) You would buy (hold) the call option and write the put option.

iii) You would write the call option and buy (hold) the put option.

iv) You would write the call option and write the put option.

B. The price of the AAPL call option above is $3.40 and the price of the put option is $3.80.

Given the strategy that you chose in question 3, draw the payoff diagram

C.Now draw its profit (as a function of the stocks price on May 1, 2015). LABEL where the profit intersects the axes with the values of X on the X-axis and the value of Y on the Y-axis). Remember that the stock price cant be less than $0.

What do the point(s) of intersection with the X-axis represent? What does the point(s) of intersection with the Y-axis represent?What is this strategy called?